10-Q 1 oa_10qxq317xdoc.htm 10-Q Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 1, 2017
 
OR
 
 
 
 
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
For the transition period from                    to                  
Commission file number 1-10582
ORBITAL ATK, INC.
(Exact name of Registrant as specified in its charter)
Delaware
(State or other jurisdiction of
incorporation or organization)
 
41-1672694
(I.R.S. Employer
Identification No.)
45101 Warp Drive
 
 
Dulles, Virginia
 
20166
(Address of principal executive offices)
 
(Zip Code)
Registrant's telephone number, including area code: (703) 406-5000


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x   No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes  x   No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
 
 
 
 
 
 
 
 
 
 
 
 
Large accelerated filer
x
 
 
 
 
Accelerated filer
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-accelerated filer
 
(Do not check if a smaller reporting company)
 
Smaller reporting company
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Emerging growth company
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o   No  x
As of October 27, 2017, there were 57,686,000 shares of the registrant's common stock outstanding.
 




TABLE OF CONTENTS
 
 
Page
PART I  Financial Information
 
 
 
 
 
 
PART II Other Information
 



PART I—FINANCIAL INFORMATION
ITEM 1.    FINANCIAL STATEMENTS
ORBITAL ATK, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(Amounts in millions except share data)
October 1, 2017
 
December 31, 2016
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
119

 
$
200

Net receivables
1,939

 
1,741

Net inventories
267

 
215

Other current assets
90

 
79

Total current assets
2,415

 
2,235

Property, plant and equipment, net of accumulated depreciation of $1,191
at October 1, 2017 and $1,121 at December 31, 2016
858

 
816

Goodwill
1,832

 
1,832

Net intangibles
70

 
98

Other noncurrent assets
362

 
437

Total assets
$
5,537

 
$
5,418

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Current portion of long-term debt
$
40

 
$
40

Accounts payable
141

 
175

Contract loss reserve
160

 
197

Contract advances and allowances
274

 
233

Accrued compensation
142

 
120

Other current liabilities
536

 
577

Total current liabilities
1,293

 
1,342

Long-term debt
1,370

 
1,398

Pension and postemployment benefits
705

 
744

Other noncurrent liabilities
106

 
117

Total liabilities
3,474

 
3,601

Commitments and contingencies (Note 12)

 

Common stock—$.01 par value: authorized—180,000,000 shares; issued and outstanding—57,685,462 shares at October 1, 2017 and 57,487,466 shares at December 31, 2016
1

 
1

Additional paid-in-capital
2,169

 
2,175

Retained earnings
1,459

 
1,266

Accumulated other comprehensive loss
(714
)
 
(764
)
Common stock in treasury, at cost—11,249,562 shares held at October 1, 2017 and 11,447,558 shares held at December 31, 2016
(863
)
 
(872
)
Total Orbital ATK, Inc. stockholders' equity
2,052

 
1,806

Noncontrolling interest
11

 
11

Total equity
2,063

 
1,817

Total liabilities and equity
$
5,537

 
$
5,418

See Notes to the Condensed Consolidated Financial Statements.

2


ORBITAL ATK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
 
 
Quarters Ended
 
Nine Months Ended
(Amounts in millions except per share data)
 
October 1, 2017
 
October 2, 2016
 
October 1, 2017
 
October 2, 2016
Sales
 
$
1,216

 
$
1,043

 
$
3,416

 
$
3,183

Cost of sales
 
941

 
833

 
2,645

 
2,466

Gross profit
 
275

 
210

 
771

 
717

Operating expenses:
 
 
 
 
 
 
 
 
Research and development
 
24

 
25

 
78

 
81

Selling
 
31

 
28

 
90

 
82

General and administrative
 
78

 
66

 
214

 
195

Income before interest, income taxes and noncontrolling interest
 
142

 
91

 
389

 
359

Net interest expense
 
(17
)
 
(17
)
 
(51
)
 
(51
)
Income before income taxes and noncontrolling interest
 
125

 
74

 
338

 
308

Income taxes
 
31

 
14

 
90

 
80

Income before noncontrolling interest
 
94

 
60

 
248

 
228

Less net income attributable to noncontrolling interest
 

 

 

 

Net income attributable to Orbital ATK, Inc.
 
$
94

 
$
60

 
$
248

 
$
228

 
 
 
 
 
 
 
 
 
Basic earnings per common share from:
 
 
 
 
 
 
 
 
Net income attributable to Orbital ATK, Inc.
 
$
1.65

 
$
1.04

 
$
4.33

 
$
3.92

Weighted-average number of common shares outstanding
 
57

 
58

 
57

 
58

Diluted earnings per common share from:
 
 
 
 
 
 
 
 
Net income attributable to Orbital ATK, Inc.
 
$
1.64

 
$
1.04

 
$
4.29

 
$
3.89

Weighted-average number of diluted common shares outstanding
 
58

 
58

 
58

 
59

Cash dividends per common share
 
$
0.32

 
$
0.30

 
$
0.96

 
$
0.90


Note: earnings per share amounts may not recalculate due to rounding. 

See Notes to the Condensed Consolidated Financial Statements.

3


ORBITAL ATK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)
 
 
Quarters Ended
 
Nine Months Ended
(Amounts in millions)
 
October 1, 2017
 
October 2, 2016
 
October 1, 2017
 
October 2, 2016
Net income
 
$
94

 
$
60

 
$
248

 
$
228

Other comprehensive income:
 
 
 
 
 
 
 
 
Pension and other postretirement benefits:
 
 
 
 
 
 
 
 
Prior service credits for pension and postretirement benefit plans recorded to net income
 
(7
)
 
33

 
(21
)
 
20

Net actuarial loss for pension and postretirement benefit plans recorded to net income
 
33

 
29

 
100

 
92

Valuation adjustment for pension and postretirement benefit plans
 

 

 

 
2

Change in fair value of derivatives
 
4

 
1

 
1

 
5

Unrealized gain on available-for-sale securities
 
1

 

 
1

 

Other
 

 
1

 

 
2

Income tax expense
 
(12
)
 
(24
)
 
(31
)
 
(46
)
Other comprehensive income, net of tax
 
19

 
40

 
50

 
75

Comprehensive income
 
113

 
100

 
298

 
303

Less comprehensive income attributable to noncontrolling interest
 

 

 

 

Comprehensive income attributable to Orbital ATK, Inc.
 
$
113

 
$
100

 
$
298

 
$
303

See Notes to the Condensed Consolidated Financial Statements.

4


ORBITAL ATK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
 
 
Nine Months Ended
(Amounts in millions)
 
October 1, 2017
 
October 2, 2016
Operating Activities
 
 
 
 
Net income
 
$
248

 
$
228

Adjustments to reconcile net income to cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
115

 
120

Fixed asset impairment
 
3

 
5

Deferred income taxes
 
13

 
(12
)
Stock-based plans expense
 
18

 
18

Other
 
4

 
11

Change in assets and liabilities:
 
 
 
 
Net receivables
 
(168
)
 
(203
)
Net inventories
 
(25
)
 
(22
)
Income taxes receivable
 

 
50

Accounts payable
 
(58
)
 
39

Contract loss reserve
 
(36
)
 
(24
)
Contract advances and allowances
 
41

 
(18
)
Accrued compensation
 
22

 
(7
)
Pension and postemployment benefits
 
40

 
(8
)
Other assets and liabilities
 
(60
)
 
(70
)
Cash flows provided by operating activities
 
157

 
107

Investing Activities
 
 
 
 
Capital expenditures
 
(138
)
 
(106
)
Cash flows used in investing activities
 
(138
)
 
(106
)
Financing Activities
 
 
 
 
Borrowings on revolving credit facilities
 
450

 
800

Payments on revolving credit facilities
 
(450
)
 
(665
)
Payment of long-term debt
 
(30
)
 
(30
)
Purchase of treasury shares
 
(32
)
 
(95
)
Dividends paid
 
(55
)
 
(53
)
Proceeds from employee stock compensation plans
 
17

 

Other
 

 
1

Cash flows used in financing activities
 
(100
)
 
(42
)
Decrease in cash and cash equivalents
 
(81
)
 
(41
)
Cash and cash equivalents at beginning of period
 
200

 
104

Cash and cash equivalents at end of period
 
$
119

 
$
63

 
 
 
 
 
Supplemental Cash Flow Disclosures
 
 
 
 
Noncash investing activity:
 
 
 
 
Capital expenditures included in accounts payable
 
$
5

 
$
4

Noncash financing activity:
 
 
 
 
Treasury shares purchased included in accounts payable
 
$

 
$
3


See Notes to the Condensed Consolidated Financial Statements.

5

ORBITAL ATK, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)


Note 1 - Basis of Presentation and Summary of Significant Accounting Policies
Nature of Operations and Basis of Presentation
The unaudited condensed consolidated financial statements of Orbital ATK, Inc. ("the Company" or "Orbital ATK") as set forth in this quarterly report have been prepared in accordance with the requirements of the U.S. Securities and Exchange Commission ("SEC") for interim reporting. As permitted under those rules, certain footnotes and other financial information that are normally required by accounting principles generally accepted in the United States ("U.S. GAAP") can be condensed or omitted. The Company's accounting policies are described in the notes to the consolidated financial statements in its Form 10-K for the year ended December 31, 2016 ("Form 10-K") filed on April 28, 2017 with the SEC.
In the opinion of management, these unaudited condensed consolidated financial statements reflect all adjustments that are of a normal recurring nature necessary for a fair presentation of the Company’s financial position as of October 1, 2017, its results of operations and comprehensive income for the quarters and nine months ended October 1, 2017 and October 2, 2016 and its cash flows for the nine months ended October 1, 2017 and October 2, 2016. The condensed consolidated balance sheet as of December 31, 2016 was derived from the audited financial statements included in the Form 10-K but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements.
The preparation of these unaudited condensed consolidated financial statements requires us to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. We base these estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying amounts of assets and liabilities that are not readily apparent from other sources. Our actual results may differ materially from these estimates. Significant estimates inherent in the preparation of our condensed consolidated financial statements include, but are not limited to, accounting for sales and cost recognition, postretirement benefit plans, environmental receivables and liabilities, evaluation of goodwill and other assets for impairment, income taxes including deferred tax assets, fair value measurements and contingencies. Intercompany balances and transactions are eliminated in consolidation.
Sales, expenses, cash flows, assets and liabilities can and do vary during the year. Therefore, the results and trends in these interim financial statements may not be the same as those for the full year. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's Form 10-K for the year ended December 31, 2016.
The Company's interim quarterly periods are based on 13-week periods and end on the Sunday closest to the last calendar day of each of March, June and September.
Change In Estimates
The majority of our sales are from long-term contracts, which are accounted for using the percentage-of-completion method. Accounting for contracts under the percentage-of-completion method requires judgment relative to assessing risks and estimating contract revenues and costs. Profits expected to be realized on contracts are based on management’s estimates of total contract value and costs at completion. Changes in estimates of contract sales, costs or profits are recognized using the cumulative catch-up method of accounting. The cumulative effect of a change in estimate is recognized in the period a change in estimate occurs. The effect of the changes on future periods of contract performance is recognized as if the revised estimate had been used since contract inception or, in the case of contracts acquired in business combinations, from the date of acquisition.
Changes in contract estimates occur for a variety of reasons including changes in contract scope, unforeseen changes in contract cost estimates due to unanticipated cost growth or risks affecting contract costs and/or the resolution of contract risks at lower costs than anticipated, termination of commercial contracts in the event of a lack of end user demand, as well as changes in contract overhead costs over the performance period. Changes in estimates could have a material effect on the Company's consolidated financial position or results of operations. Generally, favorable changes in contract estimates recognized using the cumulative catch-up method of accounting represent margin improvement on programs where either estimated cost at completion was lower than previously

6

ORBITAL ATK, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

estimated or a change in contract scope on a program caused a higher profit rate. Conversely, the unfavorable changes in contract estimates represent margin declines on programs where either estimated cost at completion was higher than previously estimated or a change in contract scope on a program caused a lower profit rate.
Aggregate net changes in contract estimates recognized increased income before income taxes and noncontrolling interest by approximately $45 million ($0.60 per diluted share) for the quarter ended October 1, 2017 and $6 million ($0.08 per diluted share) for the quarter ended October 2, 2016. Aggregate net changes in contract estimates recognized increased income before income taxes and noncontrolling interest by approximately $81 million ($1.03 per diluted share) for the nine months ended October 1, 2017 and $92 million ($1.16 per diluted share) for the nine months ended October 2, 2016. Estimated costs to complete on loss contracts at October 1, 2017 and December 31, 2016 were $967 million and $1,333 million, respectively.
Accounting Standards Updates Adopted
In October 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("ASU") 2016-17, Consolidation (Topic 810), Interests Held through Related Parties That Are under Common Control ("ASU 2016-17"). This ASU amends the consolidation guidance issued under ASU 2015-02, Consolidation (Topic 810) Amendments to the Consolidation Analysis, for those entities that are the single decision maker of a variable interest entity ("VIE") such that a single decision maker is not required to consider indirect interests held through related parties that are under common control with the single decision maker to be the equivalent of direct interest in their entirety. Instead, they are required to include those interests on a proportionate basis consistent with indirect interests held through other related parties. The amendments in this ASU were effective for annual reporting periods beginning after December 15, 2016, and interim periods within that reporting period. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
Accounting Standards Updates Issued But Not Yet Adopted
In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities (“ASU 2017-12”). The ASU amends Accounting Standard Codification ("ASC") Topic 815, Derivatives and Hedging, in order to simplify hedge accounting by better aligning an entity’s financial reporting for hedging relationships with its risk management activities. The ASU also simplifies the application of the hedge accounting guidance. ASU 2017-12 is effective for annual periods beginning after December 15, 2018, and interim periods therein. The ASU will be applied utilizing a modified retrospective approach to existing hedging relationships as of the adoption date. The Company does not expect the provisions of ASU 2017-12 to have a material impact on the Company's consolidated financial position, results of operations and cash flows.
In May 2017, the FASB issued ASU 2017-09, Modification Accounting for Share-Based Payment Arrangements (“ASU 2017-09”), which identifies and provides guidance on the types of changes to share-based payment awards that an entity would be required to apply modification accounting under ASU 2016-09, Stock Compensation (Topic 718). Specifically, an entity would not apply modification accounting if the fair value, vesting conditions and classification of the awards are the same immediately before and after the modification. ASU 2017-09 is effective for annual periods beginning after December 15, 2017 and will be applied prospectively to awards modified on or after the effective date. The Company does not expect the provisions of ASU 2017-09 to have a material impact on the Company's consolidated financial position, results of operations and cash flows.
In March 2017, the FASB issued ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost ("ASU 2017-07"). The ASU amends ASC Topic 715, CompensationRetirement Benefits, to require employers that present a measure of operating income in their statement of income to include only the service cost component of net periodic pension costs and net periodic postretirement benefit cost in operating expenses. The ASU also stipulates that only the service cost component of net benefit cost is eligible for capitalization. This guidance is effective for fiscal years beginning after December 15, 2017. Early adoption is permitted as of the beginning of an annual period for which financial statements have not been issued or made available for issuance. Disclosures of the nature of and reason for the change in accounting principle are required in the first interim and annual periods of adoption. The Company is currently evaluating the provisions of ASU 2017-07 and its impact on the Company's consolidated financial position, results of operations and cash flows.
In February 2017, the FASB issued ASU 2017-06, Plan Accounting: Defined Benefit Pension Plans (Topic 960), Defined Contribution Pension Plans (Topic 962), Health and Welfare Benefit Plans (Topic 965), Employee Benefit Plan Master Trust Reporting (“ASU 2017-06”). The ASU relates primarily to the reporting by an employee benefit plan for its interest in a master trust. The amendments in ASU 2017-06 are effective for fiscal years beginning after

7

ORBITAL ATK, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

December 15, 2018. Early adoption is permitted. An entity should apply the amendments in ASU 2017-06 retrospectively to each period for which financial statements are presented. The Company does not expect the provisions of ASU 2017-06 to have a material impact on the Company's consolidated financial position, results of operations and cash flows.
In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment ("ASU 2017-04"), which simplifies the accounting for goodwill impairments by eliminating Step 2 from the goodwill impairment test. If the carrying amount of a reporting unit exceeds its fair value, an impairment loss shall be recognized in an amount equal to that excess, versus determining an implied fair value in Step 2 to measure the impairment loss. ASU 2017-04 is effective for annual periods beginning after December 15, 2019. The Company does not expect the provisions of ASU 2017-04 to have a material impact on the Company's consolidated financial position, results of operations and cash flows.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which requires recognition of lease assets and lease liabilities for those leases classified as operating leases under previous U.S. GAAP. The new standard is effective for annual reporting periods beginning after December 15, 2018 with early adoption permitted. The Company currently is evaluating the potential changes from this ASU to its future financial reporting and disclosures.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which will replace numerous requirements in U.S. GAAP, including industry-specific requirements, and provide companies with a single revenue recognition model for recognizing revenue from contracts with customers. In July 2015, the FASB approved the deferral of the new standard's effective date by one year. The new standard will now be effective for annual reporting periods beginning after December 15, 2017. The core principle of the new standard is that a Company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. The two permitted transition methods under the new standard are the full retrospective method, in which case the standard would be applied to each prior reporting period presented, or the modified retrospective method, in which case the cumulative effect of applying the standard would be recognized at the date of initial application.
The Company will adopt the standard on January 1, 2018 and apply the modified retrospective method. The Company has substantially completed its analysis of ASU 2014-09, and the associated impact on the Company's business processes, systems and internal controls. As part of this analysis, the Company compared existing policies and procedures to the requirements of the standard and is preparing modifications to ensure appropriate application of the standard. Additionally, the Company is in the process of designing and implementing specific controls over the adoption of the new standard. The Company does not expect significant changes to current controls, however it is reviewing modifications to policies and procedures to ensure all changes are incorporated consistently. The Company is continuing its assessment of the quantitative impact of adopting ASU 2014-09 and expecting to disclose the impact in its 2017 Annual Report on Form 10-K. One area of anticipated change relates to the determination of performance obligations in a contract. The determination of the number of performance obligations could alter the timing of revenue recognition for certain contracts in the Company’s portfolio. In addition, the Company anticipates expanded disclosures related to revenues and contracts with customers as required by ASU 2014-09.
Under ASU 2014-09, revenue is recognized as the Company satisfies a performance obligation by transferring control to the customer. For performance obligations satisfied over time, the objective is to measure progress in a manner which depicts the performance of transferring control to the customer. As such, the Company expects contract revenue will generally be recognized over time using a cost incurred input measure. This is consistent with the percentage of completion cost-to-cost revenue recognition model currently used for the majority of the Company’s contracts.
Other new pronouncements issued but not effective for the Company until after October 1, 2017 are not expected to have a material impact on the Company's continuing financial position, results of operations and cash flows.



8

ORBITAL ATK, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 2 - Merger

On September 17, 2017, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Northrop Grumman Corporation (“Northrop Grumman”) and Neptune Merger, Inc., a wholly owned subsidiary of Northrop Grumman (“Sub”), under which Sub will merge with and into the Company, with the Company continuing as the surviving corporation and a wholly-owned subsidiary of Northrop Grumman (the “Merger”).

Upon the closing of the Merger, each outstanding share of Company common stock, other than shares owned by the Company, Northrop Grumman or Sub (which will be canceled) and appraisal shares, will automatically be converted into the right to receive $134.50 in cash, without interest and less any applicable withholding taxes.

The stockholders of the Company will vote on the approval of the Merger Agreement at a special meeting currently scheduled to be held on November 29, 2017. Closing is expected to occur during the first half of 2018, subject to customary closing conditions, including the stockholder vote and obtaining required regulatory approvals.
Note 3 - Fair Value of Financial Instruments
The current authoritative guidance on fair value clarifies the definition of fair value, prescribes a framework for measuring fair value, establishes a fair value hierarchy based on the inputs used to measure fair value, and expands disclosures about the use of fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.
The valuation techniques required by the current authoritative literature are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect internal market assumptions. These two types of inputs create the following fair value hierarchy:
Level 1—Quoted prices for identical instruments in active markets.
Level 2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
Level 3—Significant inputs to the valuation model are unobservable.
The following section describes the valuation methodologies used by the Company to measure its financial instruments at fair value.
Derivative financial instruments and hedging activities
In order to manage its exposure to commodity pricing, foreign currency risk and interest rate risk on debt, the Company periodically utilizes commodity, foreign currency and interest rate derivatives, which are considered Level 2 instruments. As discussed further in Note 4 - Derivative Financial Instruments, the Company has outstanding commodity forward contracts that were entered into to hedge forecasted purchases of copper and zinc, as well as outstanding foreign currency forward contracts that were entered into to hedge forecasted transactions denominated in a foreign currency. Commodity derivatives are valued based on prices of futures exchanges and recently reported transactions in the marketplace. The Company currently holds two interest rate swaps with a total notional value of $150 million. These swaps are valued based on future LIBOR rates and the established fixed rate is based primarily on quotes from banks. Foreign currency derivatives are valued based on observable market transactions of spot currency rates and forward currency prices.
The carrying amounts of the Company’s financial instruments, other than derivatives, which include net receivables, inventory, accounts payable, accrued liabilities and other current assets and liabilities, are reasonable estimates of their related fair values. The fair value of the variable-rate long-term debt is calculated based on current market rates for debt of the same risk and maturities. The fair value of the fixed-rate debt is based on market quotes for each issuance. The Company considers these to be Level 2 instruments.
The Company’s non-financial instruments measured at fair value on a non-recurring basis include goodwill, indefinite-lived intangible assets and long-lived tangible assets. The valuation methods used to determine fair value require a significant degree of management judgment to determine the key assumptions. As such, the Company

9

ORBITAL ATK, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

generally classifies non-financial instruments as either Level 2 or Level 3 fair value measurements. At October 1, 2017 and December 31, 2016, the Company did not have any non-financial instruments measured at fair value on a non-recurring basis.
Recorded carrying amount and fair value of debt was as follows (in millions):
 
 
October 1, 2017
 
December 31, 2016
 
 
Carrying Amount
 
Fair Value
 
Carrying Amount
 
Fair Value
Fixed-rate debt
 
$
700

 
$
739

 
$
700

 
$
727

Variable-rate debt
 
$
720

 
$
716

 
$
750

 
$
746

Investments in marketable securities
The Company has investments in marketable securities held in a common collective trust ("CCT") that are primarily fixed income securities used to pay benefits under a nonqualified supplemental executive retirement plan for certain executives and highly compensated employees. Investments in a collective investment vehicle are valued by multiplying the investee company's net asset value per share, as determined by the investee company, with the number of units or shares owned at the valuation date. Net asset value per share is determined by the investee company's custodian or fund administrator by deducting from the value of the assets of the investee company all of its liabilities and dividing the resulting number by the outstanding number of shares or units. Investments held by the CCT, including collateral invested for securities on loan, are valued on the basis of valuations furnished by a pricing service approved by the CCT's investment manager, which determines valuations using methods based on market transactions for comparable securities and various relationships between securities which are generally recognized by institutional traders, or at fair value as determined in good faith by the CCT's investment manager. The fair value of these securities, not subject to leveling, is included within other noncurrent assets on the Company's consolidated balance sheet. The fair value of these securities is measured on a recurring basis and was $14 million as of October 1, 2017 and $13 million as of December 31, 2016.
Note 4 - Derivative Financial Instruments
The Company is exposed to market risks arising from adverse changes in commodity prices affecting the cost of raw materials and energy, interest rates and foreign exchange risks. In the normal course of business, these risks are managed through a variety of strategies, including the use of derivative instruments.
Cash Flow Hedges
The Company periodically uses interest rate swaps to hedge forecasted interest payments and the risk associated with variable interest rates on long-term debt.
The Company entered into interest rate swaps during fiscal 2014 requiring fixed rate payments on a total notional amount of $400 million, of which $150 million remains outstanding, and receives one-month LIBOR. The fair value of interest rate swap agreements approximates the amount at which they could be settled, based on future LIBOR, and the established fixed rate is based primarily on quotes from banks.
Interest rate swap agreements entered into to manage interest costs and risk associated with variable interest rates were as follows (in millions):
 
 
Notional
 
Fair Value
 
Pay Fixed
 
Receive Floating
 
Maturity Date
Non-amortizing swap
 
$
100

 
$

 
1.69
%
 
1.24
%
 
August 2018
Non-amortizing swap
 
$
50

 
$

 
1.10
%
 
1.24
%
 
November 2017
The amount to be paid or received under these swaps is recorded as an adjustment to interest expense.
The counterparties to the interest rate swap agreements expose the Company to credit risk in the event of nonperformance. However, at October 1, 2017, the outstanding swap agreements were in a net liability position which would require the Company to make the net settlement payments to the counterparties if the agreements were settled as of that date. The Company does not anticipate nonperformance by the Company's counterparties and does not hold or issue derivative financial instruments for trading purposes.

10

ORBITAL ATK, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Commodity forward contracts are periodically used to hedge forecasted purchases of certain commodities. The contracts essentially establish a fixed price for the underlying commodity and are designated and qualify as effective cash flow hedges of purchases of the commodity. Ineffectiveness is calculated as the amount by which the change in the fair value of the derivatives exceeds the change in the fair value of the anticipated commodity purchases.
Outstanding commodity forward contracts that hedge forecasted commodity purchases were as follows (in millions):
 
 
Number of Pounds
Copper
 
17

Zinc
 
6

Due to the customer contract requirements, the benefits associated with the commodity contracts may be passed on to the customer and not realized by the Company.
The Company enters into foreign currency forward contracts to hedge forecasted transactions, denominated in foreign currencies. These transactions qualify as effective cash flow hedges and are designated as such.
Ineffectiveness with respect to forecasted transactions is calculated based on changes in the forward rate until the anticipated purchase or cash receipt occurs; ineffectiveness of the hedge of the accounts payable is evaluated based on the change in fair value of its anticipated settlement.
Outstanding foreign currency forward contracts were as follows (in millions):
 
 
Quantity Hedged
Euros sold
 
16

Euros purchased
 
52

The gains or losses on the commodity forward contracts are recorded in inventory as the commodities are purchased and in cost of sales when the related inventory is sold. The gains or losses on the foreign currency forward contracts are recorded in earnings when the related inventory is sold or customer cash receipts are received. The fair values of the commodity and foreign currency forward contracts are recorded in other assets or liabilities, as appropriate, and the effective portion is reflected in accumulated other comprehensive income (loss) in the financial statements.
Fair values in the condensed consolidated balance sheets related to derivative instruments designated as hedging instruments were as follows (in millions):
 
 
Asset Derivatives
Fair Value
 
Liability Derivatives
Fair Value
 
 
October 1, 2017
 
December 31, 2016
 
October 1, 2017
 
December 31, 2016
Commodity forward contracts(1)
 
$
7

 
$
5

 
$

 
$

Foreign currency forward contracts(1)
 
3

 
3

 
1

 

Foreign currency forward contracts(2)
 

 
1

 
1

 

Interest rate swap contracts(2)
 

 

 

 
1

Total
 
$
10

 
$
9

 
$
2

 
$
1

____________________________________________________________
(1) Location - Other current assets/Other current liabilities
(2) Location - Other noncurrent assets/Other noncurrent liabilities

11

ORBITAL ATK, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Gains and (losses) reclassified from Accumulated Other Comprehensive Loss to the condensed consolidated statements of comprehensive income related to derivative instruments were as follows (in millions):
 
 
 
 
Quarters Ended
 
 
Location
 
October 1, 2017
 
October 2, 2016
Commodity forward contracts
 
Cost of sales
 
$

 
$

Interest rate contracts
 
Interest expense
 
$

 
$
(1
)
Foreign currency contracts
 
Cost of sales
 
$
(2
)
 
$

 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended
 
 
Location
 
October 1, 2017
 
October 2, 2016
Commodity forward contracts
 
Cost of sales
 
$
(3
)
 
$
(4
)
Interest rate contracts
 
Interest expense
 
$
1

 
$
(2
)
Foreign currency contracts
 
Cost of sales
 
$
(2
)
 
$

The Company expects the remaining unrealized losses will be realized and reported in cost of sales or interest expense depending on the type of contract consistent with realized gains and losses noted in the table above. Estimated and actual gains or losses will change as market prices change.
The Company performs assessments of the effectiveness of hedge instruments on a quarterly basis and determined the hedges to be highly effective.
There was no ineffective portion of derivative instruments and no derivatives were excluded from effectiveness testing during the quarter and nine months ended October 1, 2017 and October 2, 2016; accordingly, the Company did not recognize any related gains or losses in the income statement.
All derivatives used by the Company during the periods presented were designated as hedging instruments for accounting purposes.
Note 5 - Accumulated Other Comprehensive Loss
The following table summarizes the components of Accumulated Other Comprehensive Loss, net of income taxes (in millions):
 
 
October 1, 2017
 
December 31, 2016
Derivatives
 
$
5

 
$
5

Pension and other postretirement benefits
 
(721
)
 
(771
)
Available-for-sale securities
 
2

 
2

Total Accumulated Other Comprehensive Loss
 
$
(714
)
 
$
(764
)
Note 6 - Net Inventories
Net inventories consisted of the following (in millions):
 
 
October 1, 2017
 
December 31, 2016
Raw materials
 
$
149

 
$
93

Work / contracts in process
 
94

 
121

Finished goods
 
24

 
1

Net inventories
 
$
267

 
$
215


12

ORBITAL ATK, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 7 - Postretirement Plans
The components of net periodic benefit cost for pension benefits were as follows (in millions):
 
 
Quarters Ended
 
Nine Months Ended
 
 
October 1, 2017
 
October 2, 2016
 
October 1, 2017
 
October 2, 2016
Service cost
 
$
5

 
$
5

 
$
13

 
$
14

Interest cost
 
24

 
25

 
73

 
76

Expected return on plan assets
 
(39
)
 
(41
)
 
(118
)
 
(122
)
Amortization of unrecognized net loss (1)
 
32

 
31

 
98

 
94

Amortization of unrecognized prior service cost (1)
 
(5
)
 
(5
)
 
(15
)
 
(16
)
Net periodic benefit cost
 
17

 
15

 
51

 
46

Special termination benefit cost / curtailment
 

 

 

 
2

Net periodic benefit cost
 
$
17

 
$
15

 
$
51

 
$
48

____________________________________________________________
(1) Amounts related to pension and other postemployment benefits that were reclassified from Accumulated Other Comprehensive Loss and recorded as a component of net periodic benefit cost for each period presented
During the nine months ended October 2, 2016, the Company recorded a settlement expense of $2 million to recognize the impact of lump sum benefit payments made in the nonqualified supplemental executive retirement plan.
The components of net periodic benefit income for other postretirement benefits were as follows (in millions):
 
 
Quarters Ended
 
Nine Months Ended
 
 
October 1, 2017
 
October 2, 2016
 
October 1, 2017
 
October 2, 2016
Interest cost
 
$

 
$
1

 
$
1

 
$
3

Expected return on plan assets
 

 
(1
)
 
(2
)
 
(3
)
Amortization of unrecognized net loss (1)
 

 

 
1

 
1

Amortization of unrecognized prior service cost (1)
 
(2
)
 
(1
)
 
(5
)
 
(4
)
Net periodic benefit income
 
$
(2
)
 
$
(1
)
 
$
(5
)
 
$
(3
)
____________________________________________________________
(1) Amounts related to pension and other postretirement benefits that were reclassified from Accumulated Other Comprehensive Loss and recorded as a component of net periodic benefit cost for each period presented
Effective January 1, 2016, the Company changed the approach used to measure service and interest costs for pension and other postretirement benefits. Prior to January 1, 2016, the Company measured service and interest costs utilizing a single weighted-average discount rate derived from the yield curve used to measure the plan obligations. Beginning January 1, 2016, the Company has elected to measure service and interest costs by applying the specific spot rates along that yield curve to the plans' liability cash flows.
Employer Contributions/Payments
During the nine months ended October 1, 2017, the Company made benefit payments of $3 million to retirees in connection with its nonqualified supplemental executive retirement plan and $2 million to retirees in connection with its other postretirement benefit plans. During the nine months ended October 1, 2017, the Company made $3 million of contributions to the pension trust and no contributions to the postretirement benefit plans.
During the remainder of 2017, the Company is required to make an additional pension benefit contribution of $22 million in order to meet the minimum required contributions for 2017. The Company anticipates making no contributions to the postretirement benefit plans. In addition, the Company anticipates making benefit payments of

13

ORBITAL ATK, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

approximately $1 million to retirees under the nonqualified plan and $2 million to retirees in connection with its other postretirement benefit plans during the remainder of 2017.
During the quarter ended October 2, 2016, the Company amended its retiree health care plan to provide coverage through a private exchange effective January 1, 2017. The exchange offers the retiree a broad choice of health care plans from which to choose. The Company contributes fixed payments to a Health Retirement Account ("HRA"), when applicable, for those retirees who previously had subsidized health care coverage through the Company. The Company's contributions to the HRAs are retirees' funds to be spent on qualified health care premiums and eligible out-of-pocket expenses. The plan amendment caused a remeasurement that increased the Company's funded status as of October 2, 2016 by $37 million and will reduce expenses recorded in future periods.
Note 8 - Long-term Debt
Long-term debt consisted of the following (in millions):
 
 
October 1, 2017
 
December 31, 2016
Senior Credit Facility:
 
 
 
 
Term Loan A due 2020
 
$
720

 
$
750

Revolving Credit Facility due 2020
 

 

5.25% Senior Notes due 2021
 
300

 
300

5.50% Senior Notes due 2023
 
400

 
400

Principal amount of long-term debt
 
1,420

 
1,450

Unamortized debt issuance costs:
 
 
 
 
   Senior Credit Facility
 
4

 
5

   5.25% Senior Notes due 2021
 
1

 
2

   5.50% Senior Notes due 2023
 
5

 
5

Unamortized debt issuance costs
 
10

 
12

Long-term debt less unamortized debt issuance costs
 
1,410

 
1,438

Less: Current portion of long-term debt
 
40

 
40

Long-term debt
 
$
1,370

 
$
1,398

Senior Credit Facility
In September 2015, the Company refinanced its former senior credit facility with a new senior credit facility (the "Senior Credit Facility"), which is comprised of a term loan of $800 million (the "Term Loan A") and a revolving credit facility of $1 billion (the "Revolving Credit Facility"), both of which mature in September 2020. The Term Loan A is subject to quarterly principal payments of $10 million, with the remaining balance due at maturity. Borrowings under the Senior Credit Facility bear interest at a per annum rate equal to either the sum of a base rate plus a margin or the sum of a LIBOR rate plus a margin. Each margin is based on the Company's total leverage ratio. In compliance with the terms of the Senior Credit Facility, the current base rate margin is 0.25% and the current LIBOR margin is 1.25%. The weighted-average interest rate for the Term Loan A, after taking into account the interest rate swaps, was 2.54% at October 1, 2017. The Company pays a quarterly commitment fee on the unused portion of the Revolving Credit Facility based on its total leverage ratio. Based on the Company's current total leverage ratio, this fee is currently 0.20%. As of October 1, 2017, the Company had no borrowings under the Revolving Credit Facility and had outstanding letters of credit of $181 million, which reduced amounts available on the Revolving Credit Facility to $819 million.
5.25% Senior Notes
In fiscal 2014, the Company issued $300 million aggregate principal amount of 5.25% Senior Notes (the "5.25% Notes") that mature on October 1, 2021. Interest on these notes is payable on April 1 and October 1 of each year. The Company has the right to redeem some or all of these notes from time to time on or after October 1, 2016, at specified redemption prices.

14

ORBITAL ATK, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

5.50% Senior Notes
In September 2015, the Company issued $400 million aggregate principal amount of 5.50% Senior Notes (the "5.50% Notes") that mature on October 1, 2023. Interest on these notes is payable on April 1 and October 1 of each year. The Company has the right to redeem some or all of these notes from time to time on or after October 1, 2018, at specified redemption prices.
Interest Rate Swaps
As of October 1, 2017, the Company had interest rate swap agreements in order to manage interest costs and the risk associated with variable interest rates - see Note 4 - Derivative Financial Instruments.
Rank and Guarantees
The 5.25% Notes and the 5.50% Notes are the Company's general unsecured and unsubordinated obligations and rank equally in right of payment with all of the Company’s existing and future unsecured and unsubordinated indebtedness, rank senior in right of payment to all of the Company's existing and future subordinated indebtedness and are effectively subordinated to all existing and future senior secured indebtedness, including the Senior Credit Facility, to the extent of the collateral. The 5.25% Notes and the 5.50% Notes are guaranteed on an unsecured basis, jointly and severally and fully and unconditionally, by substantially all of the Company's domestic subsidiaries. The Senior Credit Facility obligations are guaranteed on a secured basis, jointly and severally and fully and unconditionally, by substantially all of the Company's domestic subsidiaries. All of these guarantor subsidiaries are 100% owned by the Company. The Company, exclusive of these guarantor subsidiaries, has no independent operations or material assets.
Scheduled Minimum Loan Payments
The scheduled minimum loan payments on outstanding long-term debt are as follows (in millions):
Remainder of 2017
 
$
10

2018
 
40

2019
 
40

2020
 
630

2021
 
300

Thereafter
 
400

Total
 
$
1,420

Covenants and Default Provisions
The Company's Senior Credit Facility and the indentures governing the 5.25% Notes and the 5.50% Notes impose restrictions on the Company, including limitations on its ability to incur additional debt, enter into capital leases, grant liens, pay dividends and make certain other payments, sell assets, or merge or consolidate with or into another entity. In addition, the Senior Credit Facility limits the Company's ability to enter into sale-and-leaseback transactions. The Senior Credit Facility also requires the Company to meet and maintain specified financial ratios, including a minimum interest coverage ratio and a maximum consolidated total leverage ratio. The Company's debt agreements contain cross-default provisions so that noncompliance with the covenants within one debt agreement that would give rise to the right to accelerate repayment of any outstanding indebtedness could cause a default under other debt agreements as well. The Company's ability to comply with these covenants and to meet and maintain the financial ratios may be affected by events beyond its control. Borrowings under the Senior Credit Facility are subject to compliance with these covenants. The Company is in compliance with its credit agreement covenants as of October 1, 2017.

15

ORBITAL ATK, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 9 - Income Taxes
The Company's income taxes include federal, foreign and state income taxes. Income taxes for interim periods are based on estimated effective annual income tax rates.
The effective income tax rates for the quarters ended October 1, 2017 and October 2, 2016 were 24.4% and 18.0%, respectively. The increase in the rate from the quarter ended October 2, 2016 is primarily due to the impact of the favorable true up of prior-year taxes and the settlement of the examination by the Internal Revenue Service ("IRS") of the fiscal 2013 and 2014 tax returns in the quarter ended October 2, 2016 and the decrease in benefit from domestic manufacturing deduction ("DMD") in the quarter ended October 1, 2017, partially offset by the favorable changes in uncertain tax benefits, research and development ("R&D") tax credits, and state taxes in the quarter ended October 1, 2017.
The effective income tax rates for the nine months ended October 1, 2017 and October 2, 2016 were 26.5% and 25.9%, respectively. The increase in the rate from the nine months ended October 2, 2016 is primarily due to the impact of the favorable true up of prior-year taxes and the settlement of the examination by the IRS of the fiscal 2013 and 2014 tax returns in the nine months ended October 2, 2016, partially offset by favorable changes in uncertain tax benefits and R&D tax credits in the nine months ended October 1, 2017.
The Company or one of its subsidiaries files income tax returns in the U.S. federal, various U.S. state and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or foreign income tax examinations by tax authorities for years prior to 2011. The IRS has completed the audits of the Company through fiscal 2014 and is currently auditing the Company's income tax returns for fiscal year 2015 and calendar year 2015. The Company believes appropriate provisions for all outstanding issues have been made for all remaining open years in all jurisdictions.
Although the timing and outcome of audit settlements are uncertain, it is reasonably possible that a $6 million reduction of the uncertain tax benefits will occur in the next 12 months. The settlement of these unrecognized tax benefits could result in an increase in net income up to $6 million. During the quarter ended October 1, 2017, the company recognized an $11 million reduction of the uncertain tax benefits associated with the lapse of statute of limitations. This reduction has resulted in an increase in net income of $10 million in the quarter ended October 1, 2017.
Note 10 - Stock-based Compensation
The Company sponsors five stock-based incentive plans: the Orbital ATK, Inc. 2015 Stock Incentive Plan (the "2015 Stock Incentive Plan"); three legacy ATK plans (the Alliant Techsystems Inc. 2005 Stock Incentive Plan, the Non-Employee Director Restricted Stock Plan and the 1990 Equity Incentive Plan); and one legacy Orbital plan (the Orbital Sciences Corporation 2005 Amended and Restated Stock Incentive Plan), under which the Company assumed the obligation to issue Company common stock pursuant to the terms of the transaction agreement ("the Transaction Agreement") relating to the merger of the Company with Orbital Sciences Corporation and distribution of its former Sporting Group. At October 1, 2017, the Company had authorized up to 3,750,000 common shares under the 2015 Stock Incentive Plan, of which 2,083,777 common shares were available to be granted. No new grants will be made out of the other four plans. The Company adopted an Employee Stock Purchase Plan ("ESPP") during the year ended December 31, 2016. As of October 1, 2017, the Company had authorized up to 2,000,000 common shares, of which 1,781,318 common shares were available for purchase under the ESPP. In connection with the Merger, the ESPP has been suspended as of October 1, 2017.
Restricted Stock Units
Pursuant to the terms of the Transaction Agreement and under the terms of the ATK 2005 Stock Incentive Plan, all of the performance awards and Total Stockholder Return ("TSR") awards outstanding as of February 9, 2015 were converted into time-vesting restricted stock units with vesting periods corresponding to the respective performance periods. During the nine months ended October 1, 2017, 53,449 shares of restricted stock units vested for the performance period ending in 2017. As of October 1, 2017, no restricted stock units remained outstanding under the ATK 2005 Stock Incentive Plan. Pursuant to the terms of the Transaction Agreement, the Company also assumed the obligation to issue Company common stock under the legacy Orbital plan. As of October 1, 2017, there were no restricted stock units outstanding under the legacy Orbital plan as the remaining 45,120 shares of restricted stock units outstanding vested during the nine months ended October 1, 2017.

16

ORBITAL ATK, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Performance Awards
There are performance shares reserved for executive officers and key employees. Performance shares are valued at the fair value of the Company's common stock as of the grant date and expense is recognized based on the number of shares expected to vest under the terms of the award under which they are granted. Of these performance shares:
up to 58,506 will become payable upon achievement of financial performance goals relating to absolute sales growth and return on investment of capital for the performance period beginning January 1, 2017 and ending December 31, 2019; and
up to 71,074 will become payable upon achievement of financial performance goals relating to absolute sales growth and return on investment of capital for the performance period beginning January 1, 2016 and ending December 31, 2018; and
up to 79,235 will become payable upon achievement of financial performance goals relating to absolute earnings per share growth and absolute sales growth for the performance period beginning April 1, 2015 and ending December 31, 2017.
TSR Awards
There were 58,506, 71,074 and 79,235 shares reserved for TSR awards for executive officers and key employees for the fiscal year 2017-2019, 2016-2018 and 2015-2017 performance periods, respectively. The Company used an integrated Monte Carlo simulation model to determine the fair value of the TSR awards. The Monte Carlo model calculates the probability of satisfying the market conditions stipulated in the award. This probability is an input into the trinomial lattice model used to determine the fair value of the awards. There were 59,393 TSR awards granted with a weighted-average fair value of $115.26 per share during the nine months ended October 1, 2017.
Restricted Stock Awards
Restricted stock granted to certain key employees totaled 160,907 shares with a weighted-average fair value of $95.89 during the nine months ended October 1, 2017. Restricted shares vest over periods generally ranging from one to three years from the date of award and are valued at the fair value of the Company's common stock as of the grant date.
Stock Options
Stock options are granted with an exercise price equal to the fair market value of the Company's common stock on the date of grant, and generally vest from one to three years from the date of grant. Options are generally granted with seven-year or ten-year terms. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model. There were 58,434 stock options granted during the nine months ended October 1, 2017 with a weighted-average fair value of $24.47 per stock option.
Stock-based compensation expense totaled $6 million and $18 million in the quarter and nine months ended October 1, 2017 and October 2, 2016, respectively. The income tax benefit recognized for stock-based compensation was $2 million and $6 million in the quarter and nine months ended October 1, 2017 and October 2, 2016, respectively.
Share Repurchases
Shares of the Company's common stock may be purchased in the open market, subject to compliance with applicable laws and regulations and the Company’s debt covenants, depending upon market conditions and other factors. During 2016, the Board of Directors authorized an increase to the amount for repurchase of the Company's common stock to the lesser of $300 million or 4 million shares through March 2017. In February 2017, the Board of Directors further increased the amount authorized for repurchase to $450 million, removed the share quantity limitation and extended the repurchase period through March 31, 2018.
The Company repurchased 64,489 shares for $7 million and 230,918 shares for $23 million during the quarter and nine months ended October 1, 2017, respectively. The Company repurchased 576,407 shares for $44 million and 1,104,511 shares for $88 million during the quarter and nine months ended October 2, 2016, respectively. In connection with the Merger, the Company halted its share repurchase program.

17

ORBITAL ATK, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 11 - Earnings Per Share Data
Basic earnings per share ("EPS") is computed based upon the weighted-average number of common shares outstanding for each period. Diluted EPS is computed based on the weighted-average number of common shares outstanding and increased to include the dilutive effect of outstanding stock-based equity awards for each period.
In computing basic and diluted EPS for both the quarters and nine months ended October 1, 2017 and October 2, 2016, the reported earnings for each respective period were divided by the weighted-average shares outstanding, determined as follows (in millions):
 
 
Quarters Ended
 
Nine Months Ended
 
 
October 1, 2017
 
October 2, 2016
 
October 1, 2017
 
October 2, 2016
Basic weighted-average number of shares outstanding
 
57.31

 
57.93

 
57.37

 
58.21

Dilutive common share equivalents - share-based equity awards
 
0.45

 
0.33

 
0.49

 
0.43

Diluted weighted-average number of shares outstanding
 
57.76

 
58.26

 
57.86

 
58.64

Anti-dilutive stock options and other stock awards excluded from the calculation of diluted shares
 
0.15

 
0.15

 
0.22

 
0.15

Note 12 - Contingencies
Litigation
From time to time, the Company is subject to various legal proceedings, including lawsuits, which arise out of, and are incidental to, the conduct of the Company's business. The Company does not consider any of such proceedings that are currently pending, individually or in the aggregate to be material to its business or likely to result in a material adverse effect on its operating results, financial condition or cash flows, notwithstanding that the unfavorable resolution of any matter may have a material effect on net earnings in any particular quarter.
Securities Class Action
At least six purported class actions challenging the Merger have been filed in the United States District Court for the Eastern District of Virginia, captioned Lickteig v. Orbital ATK, Inc., et al., filed October 11, 2017 (the “Lickteig Action”), Ayzin v. Orbital ATK, Inc. et al., filed October 13, 2017 (the “Ayzin Action”), Sedon v. Orbital ATK, Inc., et al., filed October 16, 2017 (the “Sedon Action”), Berg v. Orbital ATK, Inc., et al., filed October 16, 2017 (the "Berg Action"), Simnowitz v. Orbital ATK, Inc. et al., filed October 18, 2017 (the "Simnowitz Action"), and Cramer v. Orbital ATK, Inc. et al, filed October 25, 2017 (the "Cramer Action" and collectively with the Lickteig Action, Ayzin Action, Sedon Action and Berg Action, the “Actions”). The Lickteig Action and Berg Action name as defendants the Company, the Company’s directors, Northrop Grumman and Sub. The Ayzin Action, the Sedon Action, the Simnowitz Action and the Cramer Action name as defendants the Company and the Company’s directors. The Actions allege certain violations of the Securities and Exchange Act of 1934, as amended, and seek, among other things, damages, attorneys’ fees and injunctive relief to prevent the Merger from closing. The Company believes that the Actions lack merit and intend to defend against them vigorously. The outcome of the Actions is uncertain. If the Actions are not resolved on a timely basis, the Actions could delay consummation of the Merger and result in substantial costs to the Company, including any costs associated with the indemnification of directors. Additional plaintiffs may file additional lawsuits against the Company and/or the directors and officers of the Company in connection with the Merger.
On August 12, 2016, a putative class action complaint, naming the Company, our Chief Executive Officer and our Chief Financial Officer as defendants, was filed in the United States District Court for the Eastern District of Virginia (Steven Knurr, et al. v. Orbital ATK, Inc., (TSE-MSN)). The class action complaint asserts claims on behalf of purchasers of Orbital ATK securities for violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the "Exchange Act") and Rule 10b-5 thereunder, arising out of allegedly false and misleading statements and the failure to disclose that: (i) the Company lacked effective control over financial reporting; and (ii) as a result, the Company failed to record an anticipated loss on its long-term contract with the U.S. Army to manufacture and supply small caliber ammunition at the U.S. Army's Lake City Army Ammunition Plant. On April 24, 2017 and October 10, 2017, the plaintiffs filed amended complaints naming additional defendants and asserting claims for violations of additional sections of the Exchange Act and alleged false and misleading statements in the Company’s Form S-4 filed with the SEC relating to the merger between the Company and Orbital Sciences Corporation. The

18

ORBITAL ATK, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

complaint seeks an award of damages, an award of reasonable costs and expenses at trial, including counsel and expert fees, and an award of such other relief as deemed appropriate by the Court. The Company is defending this action vigorously.
SEC Investigation
The SEC is conducting a non-public investigation relating to our historical accounting practices as a result of the prior restatement of the Company's unaudited condensed consolidated financial statements for the quarterly periods ended July 5, 2015 and October 4, 2015 described in the Transition Report on Form 10-K for the nine-month period ending December 31, 2015 previously filed on March 15, 2016, and the Company also has voluntarily self-reported to the SEC regarding matters pertaining to the restatement described in the Form 10-K/A for the nine-month period ending December 31, 2015 filed on February 24, 2017. The Company is cooperating fully with the SEC in connection with these matters.
U.S. Government Investigations
The Company is also subject to U.S. Government investigations from which civil, criminal or administrative proceedings could result. Such proceedings could involve claims by the U.S. Government for fines, penalties, compensatory and treble damages, restitution and/or forfeitures. Under government regulations, a company, or one or more of its operating divisions or subdivisions, can also be suspended or debarred from government contracts, or lose its export privileges, based on the results of investigations. The Company believes, based upon all available information, that the outcome of any such pending government investigations will not have a material adverse effect on its operating results, financial condition or cash flows.
Claim Recovery
Profits expected to be realized on contracts are based on management's estimates of total contract sales value and costs at completion. Estimated amounts for contract changes and claims are included in contract sales only when realization is estimated to be probable. Unbilled receivables included $10 million and $18 million as of October 1, 2017 and December 31, 2016, respectively, for contract claims.
Environmental Liabilities
The Company's operations and ownership or use of real property are subject to a number of federal, state and local environmental laws and regulations, as well as applicable foreign laws and regulations, including those for discharge of hazardous materials, remediation of contaminated sites and restoration of damage to the environment. At certain sites that the Company owns or operates or formerly owned or operated, there is known or potential contamination that the Company is required to investigate or remediate. The Company could incur substantial costs, including remediation costs, resource restoration costs, fines and penalties, or third party property damage or personal injury claims, as a result of liabilities associated with past practices or violations of environmental laws or non-compliance with environmental permits.
The Company has been identified as a potentially responsible party (“PRP”), along with other parties, in several regulatory agency actions associated with hazardous waste sites. As a PRP, the Company may be required to pay a share of the costs of the investigation and clean-up of these sites. While uncertainties exist with respect to the amounts and timing of the ultimate environmental liabilities, based on currently available information, the Company has concluded that these matters, individually or in the aggregate, will not have a material adverse effect on operating results, financial condition or cash flows.
The Company could incur substantial costs, including cleanup costs, resource restoration costs, fines and penalties or third-party property damage or personal injury claims, as a result of violations or liabilities under environmental laws or non-compliance with environmental permits. While environmental laws and regulations have not had a material adverse effect on the Company's operating results, financial condition or cash flows in the past, and the Company has environmental management programs in place to mitigate these risks, it is difficult to predict whether they will have a material impact in the future.
The liability for environmental remediation represents management's best estimate of the probable and reasonably estimable costs related to known remediation obligations. The receivable represents the amount that the Company expects to recover, as discussed below.

19

ORBITAL ATK, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

The following is a summary of the amounts recorded for environmental remediation (in millions):
 
 
October 1, 2017
 
December 31, 2016
 
 
Liability
 
Receivable
 
Liability
 
Receivable
Current
 
$
5

 
$
3

 
$
6

 
$
3

Noncurrent
 
32

 
14

 
35

 
15

Total
 
$
37

 
$
17

 
$
41

 
$
18

As of October 1, 2017, the estimated range of reasonably possible costs of environmental remediation was $37 million to $69 million.
The Company expects that a portion of its environmental compliance and remediation costs will be recoverable under U.S. Government contracts. Some of the remediation costs that are not recoverable from the U.S. Government that are associated with facilities purchased in a business acquisition are covered by various indemnification agreements, as described in Note 16 - Contingencies, to the audited consolidated financial statements included in the Company's Form 10-K.
Note 13 - Operating Segment Information
The Company operates its business within three operating segments. These operating segments ("groups") are defined based on the reporting and review process used by the Company's Chief Executive Officer and other management. The operating structure aligns the Company's capabilities and resources with its customers and markets and positions the Company for long-term growth and improved profitability.
Flight Systems Group develops rockets that are used as small- and medium-class space launch vehicles to place satellites into Earth orbit and escape trajectories, interceptor and target vehicles for missile defense systems and suborbital launch vehicles that place payloads into a variety of high-altitude trajectories. The group also develops and produces medium- and large-class rocket propulsion systems for human and cargo launch vehicles, strategic missiles, missile defense interceptors and target vehicles. Additionally, Flight Systems Group operates in the military and commercial aircraft and launch structures markets.
Defense Systems Group develops and produces small-, medium- and large-caliber ammunition, propulsion systems for tactical missiles and missile defense applications, strike weapons, precision weapons and munitions, high-performance gun systems, aircraft survivability systems, fuzes and warheads, energetic materials and special mission aircraft.
Space Systems Group develops and produces small- and medium-class satellites that are used to enable global and regional communications and broadcasting, conduct space-related scientific research and perform other activities related to national security. In addition, Space Systems Group develops and produces human-rated space systems for Earth-orbit and deep-space exploration, including cargo delivery to the International Space Station. This group is also a provider of spacecraft components and subsystems and specialized engineering and operations services to U.S. Government agencies.

20

ORBITAL ATK, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

The following summarizes the Company's results by segment (in millions):
 
 
Quarters Ended
 
Nine Months Ended
 
 
October 1, 2017
 
October 2, 2016
 
October 1, 2017
 
October 2, 2016
Sales to external customers:
 
 
 
 
 
 
 
 
Flight Systems Group
 
$
423

 
$
360

 
$
1,214

 
$
1,081

Defense Systems Group
 
511

 
451

 
1,378

 
1,326

Space Systems Group
 
282

 
232

 
824

 
776

Total external sales
 
1,216

 
1,043

 
3,416

 
3,183

Intercompany sales:
 
 
 
 
 
 
 
 
Flight Systems Group
 
3

 
3

 
8

 
10

Defense Systems Group
 
4

 
5

 
12

 
15

Space Systems Group
 
32

 
16

 
93

 
37

Corporate
 
(39
)
 
(24
)
 
(113
)
 
(62
)
Total intercompany sales
 

 

 

 

Total sales
 
$
1,216

 
$
1,043

 
$
3,416

 
$
3,183

 
 
 
 
 
 
 
 
 
Income before interest, income taxes and noncontrolling interest:
 
 
 
 
 
 
 
 
Flight Systems Group
 
$
61

 
$
44

 
$
161

 
$
152

Defense Systems Group
 
48

 
33

 
133

 
126

Space Systems Group
 
40

 
20

 
98

 
96

Corporate
 
(7
)
 
(6
)
 
(3
)
 
(15
)
Total income before interest, income taxes and noncontrolling interest
 
$
142

 
$
91

 
$
389

 
$
359

The following summarizes the Company's total assets by segment (in millions):
 
 
October 1, 2017
 
December 31, 2016
Total assets:
 
 
 
 
Flight Systems Group
 
$
2,293

 
$
2,208

Defense Systems Group
 
1,358

 
1,228

Space Systems Group
 
1,276

 
1,280

Corporate
 
610

 
702

Total assets
 
$
5,537

 
$
5,418

Certain administrative functions are primarily managed by the Company at the corporate headquarters ("Corporate"). Some examples of such functions are human resources, pension and postretirement benefits, corporate accounting, legal, tax, treasury and certain strategic growth initiatives. Significant assets and liabilities managed at Corporate include those associated with debt, restructuring, pension and postretirement benefits, environmental liabilities, litigation liabilities, strategic growth assets and income taxes.
Costs related to the administrative functions managed by Corporate are either recorded at Corporate or allocated to the segments based on the nature of the expense. The difference between pension and postretirement benefit expense calculated under U.S. GAAP and the expense calculated under U.S. Cost Accounting Standards is recorded at the corporate level which provides for greater clarity on the operating results of the business segments. Administrative expenses such as corporate accounting, legal and treasury costs are allocated out to the business segments. The amortization expense related to purchase accounting attributed to the acquisition of Orbital Sciences Corporation is also recorded in Corporate. Transactions between segments are recorded at the segment level, consistent with the Company's financial accounting policies. Intercompany balances and transactions involving different segments are eliminated at the Company's consolidated financial statements level and are shown above in Corporate.

21


ORBITAL ATK, INC.

ITEM 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-looking Information is Subject to Risk and Uncertainty
Some of the statements made and information contained in this report, excluding historical information, are "forward-looking statements" as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements give our current expectations or forecasts of future events. Words such as "may," "will," "expected," "intend," "estimate," "anticipate," "believe," "project" or "continue," and similar expressions are used to identify forward-looking statements. From time to time, we also may provide oral or written forward-looking statements in other materials released to the public. Any or all forward-looking statements in this report and in any public statements we make could be materially different. They can be affected by assumptions used or by known or unknown risks or uncertainties. Consequently, no forward-looking statements can be guaranteed. Actual results may vary materially. You are cautioned not to place undue reliance on any forward-looking statements. You should also understand that it is not possible to predict or identify all such factors and you should not consider the following list to be a complete statement of all potential risks and uncertainties. Any change in the following factors may impact the achievement of results:
the risk that the proposed transaction with Northrop Grumman may not be completed in a timely manner or at all, which may adversely affect our business and the price of our common stock;
the failure to satisfy any of the conditions to the consummation of the proposed transaction, including the receipt of certain governmental and regulatory approvals;
the occurrence of any circumstance that could give rise to the termination of the Merger Agreement;
the outcome of any legal proceedings related to the Merger Agreement or the proposed transaction, and the costs and ultimate outcome of litigation matters, government investigations and other legal proceedings;
the effect of the recent restatement of our previously issued financial results (the "Restatement") and any claims, investigations or proceedings as a result of the Restatement;
our ability to remediate the material weakness in our internal control over financial reporting described in Part I, Item 4, "Controls and Procedures," of this Form 10-Q;
reductions or changes in programs administered by the National Aeronautics and Space Administration ("NASA") or in U.S. Government military spending, timing of payments and budgetary policies, including impacts of sequestration under the Budget Control Act of 2011, and sourcing strategies;
intense competition for U.S. Government contracts and programs;
increases in costs, which the Company may not be able to react to due to the nature of its U.S. Government contracts;
changes in cost and revenue estimates and/or timing of programs;
potential termination of U.S. Government contracts and the potential inability to recover termination costs;
other risks associated with U.S. Government contracts that might expose the Company to adverse consequences;
government laws and other rules and regulations applicable to the Company, including procurement and import-export control;
reduction or change in demand and manufacturing costs for military and commercial ammunition;
the manufacture and sale of products that create exposure to potential product liability, warranty liability or personal injury claims and litigation;
risks associated with expansion into new and adjacent commercial markets;

22


ORBITAL ATK, INC.

results of acquisitions or other transactions, including our ability to successfully integrate acquired businesses and realize anticipated synergies, cost savings and other benefits, and costs incurred for pursuits and proposed acquisitions;
greater risk associated with international business, including foreign currency exchange rates and fluctuations in those rates;
federal and state regulation of defense products and ammunition;
costs of servicing the Company's debt, including cash requirements and interest rate fluctuations;
actual pension and other postretirement plan asset returns and assumptions regarding future returns, discount rates, service costs, mortality rates and health care cost trend rates;
security threats, including cyber-security and other industrial and physical security threats, and other disruptions;
supply, availability and costs of raw materials and components, including commodity price fluctuations;
performance of the Company's subcontractors;
development of key technologies and retention of a qualified workforce;
performance of our products;
fires or explosions at any of the Company's facilities;
government investigations and audits;
environmental laws that govern current and past practices and rules and regulations, noncompliance with which may expose the Company to adverse consequences;
impacts of financial market disruptions or volatility to the Company's customers and vendors;
unanticipated changes in income taxes or exposure to additional tax liabilities, including as a result of recent proposals for U.S. corporate income tax reform, and
costs and ultimate outcome of litigation matters, government investigations and other legal proceedings.
This list of factors is not exhaustive, and new factors may emerge or changes to the foregoing factors may occur that would impact our business. We undertake no obligation to update any forward-looking statements, except as required by law. A more detailed description of risk factors can be found in Part 1, Item 1A, "Risk Factors," of the Company's Form 10-K for the year ended December 31, 2016 (the "Form 10-K"). Additional information regarding these factors may be contained in the Company's subsequent filings with the Securities and Exchange Commission, including Forms 10-Q and 8-K. All such risk factors are difficult to predict, contain material uncertainties that may affect actual results, and may be beyond our control.
Executive Summary
We are an aerospace and defense systems company and supplier of products to the U.S. Government, allied nations, prime contractors and other customers. Our main products include launch vehicles and related propulsion systems, satellites and associated components and services, composite aerospace structures, tactical missiles, subsystems and defense electronics and precision weapons, armament systems and ammunition. We are headquartered in Dulles, Virginia and have operating locations throughout the United States.
We conduct business in three segments:
Flight Systems Group develops rockets that are used as small- and medium-class space launch vehicles to place satellites into Earth orbit and escape trajectories, interceptor and target vehicles for missile defense systems and suborbital launch vehicles that place payloads into a variety of high-altitude trajectories. The group also develops and produces medium- and large-class rocket propulsion systems for human and cargo

23


ORBITAL ATK, INC.

launch vehicles, strategic missiles, missile defense interceptors and target vehicles. Additionally, Flight Systems Group operates in the military and commercial aircraft and launch structures markets. The group also produces advanced flares and decoys that provide illumination for search and rescue missions and countermeasures against missile attacks.
Defense Systems Group develops and produces small-, medium- and large-caliber military ammunition, propulsion systems for tactical missiles and missile defense applications, strike weapons, precision weapons and munitions, high-performance gun systems, aircraft survivability systems, fuzes and warheads, energetic materials and special mission aircraft.
Space Systems Group develops and produces small- and medium-class satellites that are used to enable global and regional communications and broadcasting, conduct space-related scientific research and perform other activities related to national security. In addition, Space Systems Group develops and produces human-rated space systems for Earth-orbit and deep-space exploration, including cargo delivery to the International Space Station. This group is also a provider of spacecraft components and subsystems and specialized engineering and operations services to U.S. government agencies.
Financial Highlights for the Quarter Ended October 1, 2017
Quarterly sales of $1.22 billion.
Diluted earnings per share of $1.64.
New firm and option contract bookings of $1.4 billion and option exercises of $0.4 billion under existing contracts.
Total backlog of $15.7 billion, at October 1, 2017.
Income before interest, income taxes and noncontrolling interest as a percentage of sales of 11.7%.
Effective income tax rate of 24.4%.
Paid quarterly dividend of $0.32 on September 21, 2017, to stockholders of record on September 6, 2017.
Agreement and Plan of Merger
On September 17, 2017, Orbital ATK, Inc. (“Orbital ATK” or the “Company”) entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Northrop Grumman Corporation (“Northrop Grumman”) and Neptune Merger, Inc., a wholly owned subsidiary of Northrop Grumman (“Sub”), to acquire Orbital ATK for $134.50 per share in cash (the “Merger”).
The stockholders of the Company will vote on the approval of the Merger Agreement at a special meeting currently scheduled to be held on November 29, 2017. Closing is expected to occur during the first half of 2018, subject to customary closing conditions, including stockholder approval and obtaining required regulatory approvals. At the effective time of the Merger, each outstanding share of the Company’s common stock, other than shares owned by the Company, Northrop Grumman or Sub (which will be canceled) and appraisal shares, will be converted into the right to receive $134.50 in cash, without interest and less any applicable withholding taxes.
Critical Accounting Policies
The Company's significant accounting policies are described in the Form 10-K, Note 1- Summary of Significant Accounting Policies to the consolidated financial statements. The same accounting policies are used in preparing the Company's interim condensed consolidated financial statements.
In preparing the condensed consolidated financial statements, the Company follows accounting principles generally accepted in the United States ("U.S. GAAP"). The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, sales, expenses and related disclosure of contingent assets and liabilities. The Company re-evaluates its estimates on an on-going basis. The Company’s estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

24


ORBITAL ATK, INC.

More information on these policies can be found in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," of the Form 10-K.
Change in Estimates
The majority of our sales are from long-term contracts, which are accounted for using the percentage-of-completion method. Accounting for contracts under the percentage-of-completion method requires judgment relative to assessing risks and estimating contract revenues and costs. Profits expected to be realized on contracts are based on management’s estimates of total contract value and costs at completion. Changes in estimates of contract sales, costs or profits are recognized using the cumulative catch-up method of accounting. The cumulative effect of a change in estimate is recognized in the period a change in estimate occurs. The effect of the changes on future periods of contract performance is recognized as if the revised estimate had been used since contract inception or, in the case of contracts acquired in business combinations, from the date of acquisition.
Changes in contract estimates occur for a variety of reasons including changes in contract scope, unforeseen changes in contract cost estimates due to unanticipated cost growth or risks affecting contract costs and/or the resolution of contract risks at lower costs than anticipated, termination of commercial contracts in the event of a lack of end user demand, as well as changes in contract overhead costs over the performance period. Changes in estimates could have a material effect on the Company's consolidated financial position or results of operations.
Generally, favorable changes in contract estimates recognized using the cumulative catch-up method of accounting represent margin improvement on programs where either estimated cost at completion was lower than previously estimated or a change in contract scope on a program caused a higher profit rate. Conversely, the unfavorable changes in contract estimates represent margin declines on programs where either estimated cost at completion was higher than previously estimated or a change in contract scope on a program caused a lower profit rate.
The favorable and unfavorable changes in contract estimates recognized using the cumulative catch-up method of accounting are as follows (in millions):
 
 
Quarters Ended
 
Nine Months Ended
 
 
October 1, 2017
 
October 2, 2016
 
October 1, 2017
 
October 2, 2016
Gross favorable adjustments
 
$
79

 
$
106

 
$
212

 
$
251

Gross unfavorable adjustments
 
(34
)
 
(100
)
 
(131
)
 
(159
)
Net adjustments
 
$
45

 
$
6

 
$
81

 
$
92


For the quarter ended October 1, 2017, the Company recognized favorable cumulative catch-up adjustments due to higher profit expectations on programs in the Aerospace Structures division, within our Flight Systems Group, and the Satellite Systems division, within our Space Systems Group, due to better performance resulting from risk retirement and lower cost than had previously been estimated. The Company recognized unfavorable cumulative catch-up adjustments in the Launch Vehicles division, within our Flight Systems Group; the Satellite Systems division, within our Space Systems Group; and in the Missile Products division, within our Defense Systems Group, due to higher costs than had previously been estimated.

For the nine months ended October 1, 2017, the Company recognized favorable cumulative catch-up adjustments due to higher profit expectations on programs in the Aerospace Structures division, the Propulsion Systems division and the Launch Vehicles division, within our Flight Systems Group; the Satellite Systems division, within our Space Systems Group; and the Missile Products division, within our Defense Systems Group, due to better performance resulting from risk retirement and lower cost than had previously been estimated. The Company recognized unfavorable cumulative catch-up adjustments primarily due to the Aerospace Structures division, within our Flight Systems Group; the Satellite Systems division, within our Space Systems Group; and in the Armament Systems division, within our Defense Systems Group, primarily due to higher costs than had previously been estimated.

For the quarter ended October 2, 2016, the Company recognized favorable cumulative catch-up adjustments due to higher profit expectations on programs in the Aerospace Structures division, within our Flight Systems Group, and the Missile Products division, within our Defense Systems Group, due to better performance resulting from risk retirement and lower cost than had previously been estimated. The Company recognized unfavorable cumulative

25


ORBITAL ATK, INC.

catch-up adjustments primarily due to (i) in the Aerospace Structures division, within our Flight Systems Group, higher costs than had previously been estimated, (ii) in the Satellite Systems division, within our Space Systems Group, higher costs than had previously been estimated, as well as a reduction in estimated revenue on certain programs, and (iii) in the Defense Electronics division, within our Defense Systems Group, a reduction in estimated revenue on certain programs.

For the nine months ended October 2, 2016, the Company recognized favorable cumulative catch-up adjustments due to higher profit expectations on programs in the Aerospace Structures division, the Propulsion Systems division and the Launch Vehicles division, within our Flight Systems Group; the Satellite Systems division and the Advanced Programs division, within our Space Systems Group; and the Missile Products division and the Armament Systems division, within our Defense Systems Group, due to better performance resulting from risk retirement and lower cost than had previously been estimated. The Company recognized unfavorable cumulative catch-up adjustments primarily due to (i) in the Aerospace Structures division and the Propulsion Systems division, within our Flight Systems Group, higher costs than had previously been estimated, (ii) in the Satellite Systems division, within our Space Systems Group, higher costs than had previously been estimated, as well as a reduction in estimated revenue on certain programs, and (iii) in the Defense Electronics division, within our Defense Systems Group, a reduction in estimated revenue on certain programs.

The increase in the change in estimate for the quarter ended October 1, 2017 was primarily attributable to $21 million of favorable contract cumulative profit adjustments recorded in the second quarter of 2016 that normally would have been recorded in the third quarter of 2016 had we timely filed our Form 10-Q for the third quarter 2016. Additionally, overall performance on existing contracts remained strong. The decrease in the change in estimate for the nine months ended October 1, 2017 was primarily attributable to $9 million of favorable contract cumulative profit adjustments recorded in the second and third quarters of 2016 that normally would have been recorded in the fourth quarter of 2016 had we timely filed our Form 10-Q for the second and third quarters of 2016.
Results of Operations
The following information should be read in conjunction with our consolidated financial statements. The key performance indicators that management uses in managing the business are sales, income before interest, income taxes and noncontrolling interest, and cash flows.
Sales and Cost of Sales include intergroup sales and profit. Corporate and Eliminations include intergroup sales and profit eliminations and corporate expenses.
The following tables compare our unaudited condensed consolidated results of operations for the quarter and nine months ended October 1, 2017 to the quarter and nine months ended October 2, 2016 (in millions):
Sales
 
 
Quarters Ended
 
Nine Months Ended
 
 
October 1, 2017
 
October 2, 2016
 
Change
 
Percent Change
 
October 1, 2017
 
October 2, 2016
 
Change
 
Percent Change
Flight Systems Group
 
$
426

 
$
363

 
$
63

 
17.4
 %
 
$
1,222

 
$
1,091

 
$
131

 
12.0
 %
Defense Systems Group
 
515

 
456

 
59

 
12.9
 %
 
1,390

 
1,341

 
49

 
3.7
 %
Space Systems Group
 
314

 
248

 
66

 
26.6
 %
 
917

 
813

 
104

 
12.8
 %
Corporate and Eliminations
 
(39
)
 
(24
)
 
(15
)
 
(62.5
)%
 
(113
)
 
(62
)
 
(51
)
 
(82.3
)%
Total sales
 
$
1,216

 
$
1,043

 
$
173

 
16.6
 %
 
$
3,416

 
$
3,183

 
$
233

 
7.3
 %
Fluctuations in sales were driven by program-related changes within the operating segments as described below.
Quarter:
Flight Systems Group
The increase was driven by higher sales of $41 million in Aerospace Structures due to increased production on composite aircraft and launch vehicles components and increased sales of $25 million in Launch Vehicles due to a new medium range ballistic missile program and increased activity on small satellite launch programs.

26


ORBITAL ATK, INC.

Defense Systems Group
The increase was due to higher sales of $33 million in Armament Systems driven by international business, $19 million in Missile Products due to higher production levels of advanced propulsion, fuze and warhead and ammunition and $14 million in Defense Electronics driven by light attack aircraft production. These increases were partially offset by a decrease of $5 million in Small Caliber Systems primarily attributable to production delays resulting from an industrial accident that occurred in the Lake City Army Ammunition Plant.
Space Systems Group
The increase was due to higher sales of $41 million in Satellite Systems driven by strength in Government Satellites partially offset by weakness in Commercial Satellites. In addition, Advanced Programs was higher by $10 million due to increased Mission Extension Vehicle ("MEV") activity, partially offset by decreased Commercial Resupply Services ("CRS") activity. The increase was also due to higher sales of $13 million in Space Components as a result of increased activity on existing programs and $6 million in Technical Services driven by activities on our NASA and Navy contracts.

Corporate and Eliminations
The change in Corporate and Eliminations was primarily due to an increase in intercompany activity, which is eliminated in consolidation.
Nine Months:
Flight Systems Group
The increase in sales was driven by higher sales of $98 million in Aerospace Structures due to increased production on composite aircraft. The increase was also driven by higher sales in Launch Vehicles of $40 million due to a new medium range ballistic missile program and increased activity on small satellite launch programs, offset by reduced production on existing missile defense programs. These increases were partially offset by a decrease of $5 million in Propulsion Systems due to the near completion of a commercial rocket motor program.
Defense Systems Group
The increase in sales was due to an increase of $44 million in Armament Systems driven by international sales, $33 million in Missile Products due to higher production level on tactical propulsion and $32 million in Defense Electronics due to higher light attack aircraft production. These increases were partially offset by a decrease of $65 million in Small Caliber Systems primarily attributable to production delays resulting from an industrial accident that occurred in the Lake City Army Ammunition Plant.
Space Systems Group
The increase was due to higher sales of $92 million in Satellite Systems driven by strength in Government Satellites partially offset by weakness in Commercial Satellites. In addition, Advanced Programs decreased by $9 million due to lower CRS activity, partially offset by increased MEV activity. The increase was also driven by higher sales of $15 million in Space Components as a result of increased activity on existing programs and $9 million in Technical Services driven by activities on our Navy contracts.
Corporate and Eliminations
The change in Corporate and Eliminations was primarily due to an increase in intercompany activity, which is eliminated in consolidation.

27


ORBITAL ATK, INC.

Cost of Sales
 
 
Quarters Ended
 
Nine Months Ended
 
 
October 1, 2017
 
October 2, 2016
 
Change
 
Percent Change
 
October 1, 2017
 
October 2, 2016
 
Change
 
Percent Change
Flight Systems Group
 
$
326

 
$
278

 
$
48

 
17.3
 %
 
$
931

 
$
813

 
$
118

 
14.5
 %
Defense Systems Group
 
414

 
379

 
35

 
9.2
 %
 
1,112

 
1,087

 
25

 
2.3
 %
Space Systems Group
 
250

 
208

 
42

 
20.2
 %
 
752

 
647

 
105

 
16.2
 %
Corporate and Eliminations
 
(49
)
 
(32
)
 
(17
)
 
(53.1
)%
 
(150
)
 
(81
)
 
(69
)
 
(85.2
)%
Total cost of sales
 
$
941

 
$
833

 
$
108

 
13.0
 %
 
$
2,645

 
$
2,466

 
$
179

 
7.3
 %
The fluctuation in cost of sales was due to program-related changes within the operating segments as described below.
Quarter:
Flight Systems Group
The increase was primarily due to higher cost of sales of $27 million in Aerospace Structures due to increased production on composite aircraft and launch vehicles components. The increase was also due to higher cost of sales of $24 million in Launch Vehicles due to a new medium range ballistic missile program and increased activity on small satellite launch programs.
Defense Systems Group
The increase was due to higher cost of sales of $18 million in Armament Systems due to increased international sales, $13 million in Missile Products due to higher production of advanced propulsion, fuze and warhead and ammunition and $13 million in Defense Electronics driven by production level in light attack aircraft. These increases were partially offset by a decrease of $9 million in Small Caliber Systems primarily attributable to production delays resulting from an industrial accident that occurred in the Lake City Army Ammunition Plant.
Space Systems Group
The increase was due to higher cost of sales of $28 million in Satellite Systems driven by increased activity in Government Satellites partially offset by weakness in Commercial Satellites. Advanced Programs was higher by $4 million due to increased MEV activity, partially offset by decreased CRS activity. In addition, Space Components increased $9 million and Technical Services increased by $4 million due to new and existing programs.
Corporate and Eliminations
The change in Corporate and Eliminations was primarily due to an increase in intercompany activity, which is eliminated in consolidation.
Nine Months:
Flight Systems Group
The increase was due to higher cost of sales of $76 million in Aerospace Structures due to increased production on composite aircraft. The increase was also driven by higher cost of sales in Launch Vehicles of $49 million due to a new medium range ballistic missile program and activity related to additional missions on Antares, offset by reduced production on existing missile defense programs.
Defense Systems Group
The increase was due to higher cost of sales of $29 million in Defense Electronics due to higher light attack aircraft production, $27 million in Missile Products due to increased tactical propulsion production and $23 million in Armament Systems due to international sales. These increases were partially offset by a decrease of $54 million in Small Caliber Systems primarily attributable to production delays resulting from an industrial accident that occurred in the Lake City Army Ammunition Plant.

28


ORBITAL ATK, INC.

Space Systems Group
The increase was due to higher cost of sales of $82 million in Satellite Systems driven by increased activity in Government Satellites partially offset by weakness in Commercial Satellites. Advanced Programs was higher by $8 million due to increased MEV activity. In addition, Space Components increased $10 million and Technical Services increased by $8 million due to new and existing programs.
Corporate and Eliminations
The change in Corporate and Eliminations was primarily due to an increase in intercompany activity, which is eliminated in consolidation.
Operating Expenses
 
 
Quarters Ended
 
Nine Months Ended
 
 
October 1, 2017
 
Percent of Sales
 
October 2, 2016
 
Percent of Sales
 
Change
 
October 1, 2017
 
Percent of Sales
 
October 2, 2016
 
Percent of Sales
 
Change
Research and development
 
$
24

 
2.0
%
 
$
25

 
2.4
%
 
$
(1
)
 
$
78

 
2.3
%
 
$
81

 
2.5
%
 
$
(3
)
Selling
 
31

 
2.5
%
 
28

 
2.7
%
 
3

 
90

 
2.6
%
 
82

 
2.6
%
 
8

General and administrative
 
78

 
6.4
%
 
66

 
6.3
%
 
12

 
214

 
6.3
%
 
195

 
6.1
%
 
19

Total operating expenses
 
$
133

 
10.9
%
 
$
119

 
11.4
%
 
$
14

 
$
382

 
11.2
%
 
$
358

 
11.2
%
 
$
24

Quarter:
Operating expenses increased $14 million in the quarter ended October 1, 2017 compared to the quarter ended October 2, 2016 primarily due to transaction expenses related to the proposed acquisition by Northrop Grumman, which we refer to as acquisition transaction expenses as well as legal fees related to the restatement of our historical financial statements.
Nine Months:
Operating expenses increased $24 million in the nine months ended October 1, 2017 compared to the nine months ended October 2, 2016 primarily due to acquisition transaction expenses and legal and audit fees related to the restatement of our historical financial statements. Additionally, selling expenses increased due to higher bid and proposal expenses in Flight Systems Group and Defense Systems Group.
Income Taxes
 
 
Quarters Ended
 
Nine Months Ended
 
 
October 1, 2017
 
Effective Rate
 
October 2, 2016
 
Effective Rate
 
Change
 
October 1, 2017
 
Effective Rate
 
October 2, 2016
 
Effective Rate
 
Change
Income taxes
 
$
31

 
24.4
%
 
$
14

 
18.0
%
 
$
17

 
$
90

 
26.5
%
 
$
80

 
25.9
%
 
$
10

Quarter:
The effective income tax rates for the quarters ended October 1, 2017 and October 2, 2016 were 24.4% and 18.0%, respectively. The increase in the rate from the quarter ended October 2, 2016 is primarily due to the impact of the favorable true up of prior-year taxes and the settlement of the examination by the Internal Revenue Service ("IRS") of the fiscal 2013 and 2014 tax returns in the quarter ended October 2, 2016 and the decrease in benefit from domestic manufacturing deduction ("DMD") in the quarter ended October 1, 2017, partially offset by the favorable changes in uncertain tax benefits, research and development ("R&D") tax credits, and state taxes in the quarter ended October 1, 2017.

29


ORBITAL ATK, INC.

Nine Months:
The effective income tax rates for the nine months ended October 1, 2017 and October 2, 2016 were 26.5% and 25.9%, respectively. The increase in the rate from the nine months ended October 2, 2016 is primarily due to the impact of the favorable true up of prior-year taxes and the settlement of the examination by the IRS of the fiscal 2013 and 2014 tax returns in the nine months ended October 2, 2016, partially offset by favorable changes in uncertain tax benefits and R&D tax credits in the nine months ended October 1, 2017.
Liquidity and Capital Resources
We manage our business to maximize operating cash flows as the primary source of liquidity. In addition to cash on hand and cash generated by operations, sources of liquidity include a credit facility, long-term borrowings, and access to the public debt and equity markets. We use our cash to fund investments in our existing core businesses and for debt repayment, cash dividends, share repurchases, acquisitions and other activities.
Cash Flow Summary
Our cash flows for operating, investing and financing activities, as reflected in the condensed consolidated statements of cash flows are summarized as follows (in millions):
 
 
Nine Months Ended
 
 
October 1, 2017
 
October 2, 2016
Cash provided by operating activities
 
$
157

 
$
107

Cash used in investing activities
 
(138
)
 
(106
)
Cash used in financing activities
 
(100
)
 
(42
)
Net cash flows
 
$
(81
)
 
$
(41
)
Operating Activities
Cash provided by operating activities during the nine months ended October 1, 2017 was $157 million, compared to cash provided by operating activities of $107 million during the nine months ended October 2, 2016. The increase in operating cash flows resulted primarily from the net effect of changes in working capital and other assets and liabilities and by a $20 million increase in net income. During the nine months ended October 1, 2017, changes in working capital and other assets and liabilities used $244 million of cash, comprised primarily of a $168 million increase in net receivables, a $58 million decrease in accounts payable, a $36 million decrease in contract loss reserve, a $25 million increase in net inventories and a $60 million change in other assets and liabilities, offset by a $41 million increase in contract advances and allowances, a $40 million increase in pension and postemployment benefits and a $22 million increase in accrued compensation.
During the nine months ended October 2, 2016, changes in working capital and other assets and liabilities used $263 million of cash, comprised primarily of a $203 million increase in net receivables, a $22 million increase in net inventories, a $24 million decrease in contract loss reserve, a $7 million decrease in accrued compensation, an $8 million decrease in pension and postemployment benefits, an $18 million decrease in contract advances and allowances and a $70 million change in other assets and liabilities, offset by a $50 million decrease in income taxes receivable and a $39 million increase in accounts payable.
Investing Activities
Cash used in investing activities consisted of capital expenditures and was $138 million and $106 million during the nine months ended October 1, 2017 and October 2, 2016, respectively. The increase was primarily due to capitalized costs for our self-constructed Mission Extension Vehicle asset of $66 million during the nine months ended October 1, 2017. The vehicle will provide in-orbit satellite life extension services when completed.
Financing Activities
Cash used in financing activities during the nine months ended October 1, 2017 was $100 million, compared to cash used in financing activities of $42 million for the nine months ended October 2, 2016. The increase in cash used in financing activities is due primarily to lower net borrowings of $135 million on our Senior Credit Facility, offset partially by a decrease in share repurchases and an increase in proceeds from employee stock compensation plans.

30


ORBITAL ATK, INC.

Liquidity
In addition to our normal operating cash requirements, our principal future cash requirements will be to fund capital expenditures, repay debt, satisfy employee benefit obligations, repurchase shares, pay dividends and complete any strategic acquisitions. Our short-term cash requirements for operations are expected to consist mainly of capital expenditures to maintain and expand production facilities and working capital requirements. Our debt service requirements over the next two years consist of principal payments due under the Senior Credit Facility, as discussed further below. Our other debt service requirements consist of interest expense on our debt.
During the nine months ended October 1, 2017, we paid dividends totaling $55 million. The payment and amount of any future dividends are at the discretion of our Board of Directors and will be based on a number of factors, including our earnings, liquidity position, financial condition, capital requirements, credit ratings and the availability and cost of obtaining new debt. Under the terms of the Merger Agreement with Northrop Grumman, we are permitted to, and intend to, continue paying a $0.32 per share quarterly cash dividend until the closing of the transaction. However, we are not permitted to increase the per share dividend under the terms of the Merger Agreement.
Based on our current financial condition, we believe our cash position, combined with anticipated generation of cash flows, as well as the availability of funding, if needed, through our Senior Credit Facility, access to debt and equity markets, and potential future sources of funding such as additional bank financing and debt markets, will be adequate to fund future growth as well as service our anticipated long-term debt and pension obligations, make capital expenditures and pay dividends over the next 12 months.
We do not expect our access to liquidity sources will be materially impacted in the near future. There can be no assurance, however, that the cost or availability of future borrowings, if any, will not be materially impacted by capital market conditions.
Long-term Debt and Credit Facilities
As of October 1, 2017, we had outstanding total indebtedness of $1,420 million and the potential of additional borrowings of up to $819 million on our $1 billion Revolving Credit Facility, reduced for outstanding letters of credit of $181 million.
Our outstanding indebtedness consisted of the following (in millions):
 
 
October 1, 2017
 
December 31, 2016
Senior Credit Facility:
 
 
 
 
Term Loan A due 2020
 
$
720

 
$
750

Revolving Credit Facility due 2020
 

 

5.25% Senior Notes due 2021
 
300

 
300

5.50% Senior Notes due 2023
 
400

 
400

Principal amount of long-term debt
 
1,420

 
1,450

Unamortized debt issuance costs:
 
 
 
 
  Senior Credit Facility
 
4

 
5

  5.25% Senior Notes due 2021
 
1

 
2

  5.50% Senior Notes due 2023
 
5

 
5

Unamortized debt issuance costs
 
10

 
12

Long-term debt less unamortized debt issuance costs
 
1,410

 
1,438

Less: Current portion of long-term debt
 
40

 
40

Long-term debt
 
$
1,370

 
$
1,398


31


ORBITAL ATK, INC.

Covenants
As of October 1, 2017, our specified financial ratios that our Credit Agreement requires us to meet are as follows:
 
 
Total Leverage Ratio (1)
 
Interest Coverage Ratio (2)
Requirement
 
4.00

 
3.00

Actual at October 1, 2017
 
1.98

 
11.16

____________________________________________________________
(1) Not to exceed the required financial ratio
(2) Not to be below the required financial ratio
Total Leverage Ratio is the sum of our total debt plus financial letters of credit, net of up to $100 million of cash, divided by Covenant Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA") (which includes adjustments for items such as nonrecurring or extraordinary noncash items, noncash charges related to stock-based compensation and intangible asset impairment charges, as well as the inclusion of EBITDA of acquired companies on a pro forma basis) for the past four fiscal quarters. Interest Coverage Ratio is Covenant EBITDA divided by cash payments for interest expense. The Company is in compliance with its credit agreement covenants as of October 1, 2017.
Our debt agreements contain cross-default provisions so that noncompliance with the covenants within one debt agreement that would give rise to the right to accelerate repayment of any outstanding indebtedness could cause a default under other debt agreements as well. Our ability to comply with these covenants in the future and to meet and maintain the requisite financial ratios may be affected by events beyond our control.
See Note 8 - Long-term Debt to the condensed consolidated financial statements in Part I, Item 1, "Financial Statements," for a detailed discussion of our borrowings and the associated covenants in our debt agreements.
Share Repurchases
Shares of our common stock may be purchased from time to time in the open market, subject to compliance with applicable laws and regulations and our debt covenants, depending upon market conditions and other factors. During 2016, the Board of Directors authorized an increase to the amount for repurchase of the Company's common stock to the lesser of $300 million or 4 million shares through March 31, 2017. On February 27, 2017, the Board of Directors further increased the amount authorized for repurchase to $450 million, removed the share quantity limitation and extended the repurchase period through March 31, 2018. We repurchased 64,489 shares for $7 million and 230,918 shares for $23 million during the quarter and nine months ended October 1, 2017. We repurchased 576,407 shares for $44 million and 1,104,511 shares for $88 million during the quarter and nine months ended October 2, 2016. In connection with the Merger, the Company halted its share repurchase program.
Contractual Obligations and Commercial Commitments
There have been no material changes at October 1, 2017 with respect to the contractual obligations and commitments or off-balance sheet arrangements described in the Form 10-K.
Contingencies
Environmental Liabilities
Our operations and ownership or use of real property are subject to a number of federal, state, and local environmental laws and regulations, as well as applicable foreign laws and regulations, including those for discharge of hazardous materials, remediation of contaminated sites and restoration of damage to the environment. At certain sites that we own or operate or formerly owned or operated, there is known or potential contamination that we are required to investigate or remediate. We could incur substantial costs, including remediation costs, resource restoration costs, fines and penalties, or third party property damage or personal injury claims, as a result of liabilities associated with past practices or violations of environmental laws or noncompliance with environmental permits.

32


ORBITAL ATK, INC.

The liability for environmental remediation represents management's best estimate of the probable and reasonably estimable costs related to known remediation obligations. The receivable represents the amount that we expect to recover, as discussed below.
We expect that a portion of our environmental compliance and remediation costs will be recoverable under U.S. Government contracts. Some of the remediation costs that are not recoverable from the U.S. Government that are associated with facilities purchased in a business acquisition are covered by various indemnification agreements, as described in Note 16 - Contingencies to the audited consolidated financial statements included in our Form 10-K for the year ended December 31, 2016.
We have been identified as a potentially responsible party ("PRP"), along with other parties, in several regulatory agency actions associated with hazardous waste sites. As a PRP, we may be required to pay a share of the costs of the investigation and clean-up of these sites. While uncertainties exist with respect to the amounts and timing of the ultimate environmental liabilities, based on currently available information, we have concluded that these matters, individually or in the aggregate, will not have a material adverse effect on our operating results, financial condition or cash flows.
Other Contingencies
We are also subject to a number of other potential risks and contingencies. These risks and contingencies are described in Item 1A, "Risk Factors," of Part I of the Form 10-K.
New Accounting Pronouncements
See Note 1 - Basis of Presentation and Summary of Significant Accounting Policies to the unaudited condensed consolidated financial statements in Item 1 of Part I, "Financial Statements," of this report.
ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There were no material changes in our market risk during the nine months ended October 1, 2017. For additional information, refer to Item 7A, "Quantitative and Qualitative Disclosures about Market Risk," of Part II of our Form 10-K for the year ended December 31, 2016.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
As of October 1, 2017, management of the Company, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). As described in Management’s Report on Internal Control over Financial Reporting in Item 9A of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016, we previously reported the following material weakness in internal control over financial reporting that existed as of December 31, 2016 related to:
(i)
Designing and maintaining controls related to the preparation, review and approval of costs incurred and contract estimates used to determine revenue at the Small Caliber Systems Division.
This material weakness in our internal control over financial reporting was not remediated as of October 1, 2017. As a result, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of October 1, 2017.
Remediation of Material Weaknesses
During the quarter ended October 1, 2017, the Company completed the remediation actions for one previously identified material weakness related to maintaining an effective control environment at our Defense Systems Group and its Small Caliber Systems Division.
For the material weakness listed above that was not remediated as of October 1, 2017, management believes it has made meaningful progress toward improving and strengthening the affected internal controls. Management has substantially completed the following remediation actions and is currently testing the operating effectiveness of the relevant controls:

33


ORBITAL ATK, INC.

(i) We completed a detailed review of the long-term contract with the U.S. Army to manufacture and supply small caliber ammunition at the Lake City Army Ammunition Plant and the underlying estimates for its percentage of completion revenue recognition accounting model and developed extensive analysis and procedures to develop our management estimates in the estimate at completion (“EAC”). Furthermore, this detailed review led to the implementation of a more robust and standard EAC model where we have enhanced management controls and oversight.
We continue to monitor and enhance our control environment and will make further changes as appropriate. We believe the remediation steps outlined above have improved and will continue to improve the effectiveness of our internal control over financial reporting. While we have made meaningful progress on strengthening our internal controls relative to this material weakness, we have not fully tested all our remediation actions to verify the effectiveness of their design or operation.
Changes in Internal Control over Financial Reporting
During the quarter ended October 1, 2017, there were no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) other than changes related to the remediation of the material weakness described above, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.


34


ORBITAL ATK, INC.

PART II—OTHER INFORMATION
ITEM 1.    LEGAL PROCEEDINGS
From time to time, we are subject to various legal proceedings, including lawsuits, which arise out of, and are incidental to, the conduct of our business. We do not consider any of such proceedings that are currently pending, individually or in the aggregate to be material to our business or likely to result in a material adverse effect on our future operating results, financial condition or cash flows, notwithstanding that the unfavorable resolution of any matter may have a material effect on our net earnings in any particular quarter.
Securities Class Action. At least six purported class actions challenging the Merger have been filed in the United States District Court for the Eastern District of Virginia, captioned Lickteig v. Orbital ATK, Inc., et al., filed October 11, 2017 (the “Lickteig Action”), Ayzin v. Orbital ATK, Inc. et al., filed October 13, 2017 (the “Ayzin Action”), Sedon v. Orbital ATK, Inc., et al., filed October 16, 2017 (the “Sedon Action”), Berg v. Orbital ATK, Inc., et al., filed October 16, 2017 (the "Berg Action"), Simnowitz v. Orbital ATK, Inc. et al., filed October 18, 2017 (the "Simnowitz Action"), and Cramer v. Orbital ATK, Inc. et al, filed October 25, 2017 (the "Cramer Action" and collectively, with the Lickteig Action, Ayzin Action, Sedon Action, Berg Action, and Simnowitz, the “Actions”). The Lickteig Action and the Berg Action name as defendants the Company, the Company’s directors, Northrop Grumman and Sub. The Ayzin Action, the Sedon Action, the Simnowitz Action and the Cramer Action name as defendants the Company and the Company’s directors. The Actions allege certain violations of the Securities and Exchange Act of 1934, as amended, and seek, among other things, damages, attorneys’ fees and injunctive relief to prevent the Merger from closing. The Company believes that the Actions lack merit and intend to defend against them vigorously. If the Actions are not resolved on a timely basis, the Actions could delay consummation of the Merger and result in additional costs to the Company, including costs associated with the indemnification of directors. Additional plaintiffs may file lawsuits against the Company and/or its directors and officers in connection with the Merger.
On August 12, 2016, a putative class action complaint, naming the Company, our Chief Executive Officer and our Chief Financial Officer as defendants, was filed in the United States District Court for the Eastern District of Virginia (Steven Knurr, et al. v. Orbital ATK, Inc., No. 16-cv-01031 (TSE-MSN)). The class action complaint asserts claims on behalf of purchasers of Orbital ATK securities for violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the "Exchange Act") and Rule 10b-5 thereunder, arising out of allegedly false and misleading statements and the failure to disclose that: (i) the Company lacked effective control over financial reporting; and (ii) as a result, the Company failed to record an anticipated loss on its long-term contract with the U.S. Army to manufacture and supply small caliber ammunition at the U.S. Army's Lake City Army Ammunition Plant. On April 24, 2017 and October 10, 2017, the plaintiffs filed amended complaints naming additional defendants and asserting claims for violations of additional sections of the Exchange Act and alleged false and misleading statements in the Company’s Form S-4 filed with the SEC relating to the merger between the Company and Orbital Sciences Corporation. The complaint seeks an award of damages, an award of reasonable costs and expenses at trial, including counsel and expert fees, and an award of such other relief as deemed appropriate by the Court.
SEC Investigation. The SEC is conducting a non-public investigation relating to our historical accounting practices as a result of the prior restatement of the Company’s unaudited condensed consolidated financial statements for the quarterly periods ended July 5, 2015 and October 4, 2015 as described in the Company's Amendment to the Transition Report on Form 10-K for the nine-month transition period ending December 31, 2015 filed on March 15, 2016. The Company has also voluntarily self-reported to the SEC regarding matters pertaining to the Restatement described in the Company's Amendment to the Transition Report on Form 10-K for the nine-month transition period ending December 31, 2015 filed on February 24, 2017. The Company is cooperating fully with the SEC in connection with these matters.
U.S. Government Investigations. We are also subject to U.S. Government investigations from which civil, criminal or administrative proceedings could result. Such proceedings could involve claims by the U.S. Government for fines, penalties, compensatory and treble damages, restitution and/or forfeitures. Under government regulations, a company, or one or more of its operating divisions or subdivisions, can also be suspended or debarred from government contracts, or lose its export privileges, based on the results of investigations. We believe, based upon all available information, that the outcome of any such pending government investigations will not have a material adverse effect on our operating results, financial condition or cash flows.
Environmental Liabilities. Our operations and ownership or use of real property are subject to a number of federal, state, and local laws and regulations, including those for discharge of hazardous materials, remediation of

35


ORBITAL ATK, INC.

contaminated sites, and restoration of damage to the environment. Due in part to their complexity and pervasiveness, such laws and regulations have resulted in our Company being involved with a number of related legal proceedings, claims and remediation obligations. We routinely assess, based on in-depth studies, expert analyses and legal reviews, our contingencies, obligations, and commitments for remediation of contaminated sites and past practices, including assessments of ranges and probabilities of recoveries from other responsible parties. Our policy is to accrue and charge to expense in the current period any identified exposures related to environmental liabilities based on estimates of investigation, cleanup, monitoring and resource restoration costs to be incurred.
We have been identified as a PRP, along with other parties, in several regulatory agency actions associated with hazardous waste sites. As a PRP, we may be required to pay a share of the costs of the investigation and clean-up of these sites. While uncertainties exist with respect to the amounts and timing of the ultimate environmental liabilities, based on currently available information, we have concluded that these matters, individually or in the aggregate, will not have a material adverse effect on our operating results, financial condition or cash flows.
We could incur substantial costs, including cleanup costs, resource restoration costs, fines, and penalties or third-party property damage or personal injury claims, as a result of violations or liabilities under environmental laws or noncompliance with environmental permits. While environmental laws and regulations have not had a material adverse effect on our operating results, financial condition or cash flows in the past, and we have environmental management programs in place to mitigate these risks, it is difficult to predict whether they will have a material impact in the future.
The description of certain environmental matters contained in Part I, Item 2, "Management’s Discussion and Analysis of Financial Condition and Results of Operations" under the heading "Contingencies," is incorporated herein by reference.
ITEM 1A.    RISK FACTORS
While we attempt to identify, manage and mitigate risks and uncertainties associated with our business to the extent practical under the circumstances, some level of risk and uncertainty will always be present. Item 1A, "Risk Factors," of Part I of our Report on Form 10-K for the year ended December 31, 2016 ("Form 10-K"), describes material risks and uncertainties associated with our business. These risks and uncertainties have the potential to materially affect our business, financial condition, results of operations, cash flows, projected results and future prospects.
On September 17, 2017, we entered into an Agreement and Plan of Merger with Northrop Grumman and Neptune Merger, Inc., a wholly owned subsidiary of Northrop Grumman, to acquire Orbital ATK (the "Merger"). See Part 1, Item 2 of this report. For additional information regarding the Merger, please see our Current Report on Form 8-K filed on September 18, 2017. In addition to the risks we identified in our Form 10-K, we have identified the following risks related to the Merger:
Failure to complete the Merger could negatively impact the price of our common stock, as well as our future business and financial results.

The Merger Agreement contains a number of conditions that must be satisfied or waived prior to the completion of the Merger. We cannot assure you that all of the conditions to the Merger will be so satisfied or waived. If the conditions to the Merger are not satisfied or waived, we may be unable to complete the Merger.

If the Merger is not completed, our ongoing business may be adversely affected as follows: (i) we may experience negative reactions from the financial markets, including negative impacts on the market price of our common stock; (ii) some of management's attention will have been directed to the Merger instead of being directed to our own operations and the pursuit of other opportunities that could have been beneficial to us; (iii) the manner in which customers, suppliers and other third parties perceive us may be negatively impacted, which in turn could affect our ability to compete for business; (iv) we may experience negative reactions from employees; (v) we will have expended time and resources that could otherwise have been spent on our existing business; and (vi) we may be required, in certain circumstances, to pay a termination fee of $275 million, as provided in the Merger Agreement.

Additionally, in approving the Merger Agreement, the Board of Directors considered a number of factors and potential benefits, including the fact that the Merger consideration to be received by holders of our common stock

36


ORBITAL ATK, INC.

represented a 22.2% premium to the closing price of our common stock on September 15, 2017. If the Merger is not completed, neither the Company nor the holders of our common stock will realize this benefit of the Merger. Moreover, we would also have nevertheless incurred substantial transaction-related fees and costs and the loss of management time and resources.

The Merger is conditioned on, among other things, the approval of our stockholders. The special meeting of our stockholders to consider and vote upon the Merger and related matters is currently scheduled to be held on November 29, 2017.

A significant delay in consummating or a failure to consummate the Merger could have a material adverse effect on the price of our common stock and our operating results.

Because the Merger is subject to certain closing conditions, it is possible that the Merger may not be completed or may not be completed as quickly as expected. If the Merger is not completed, it could have a material adverse effect on the price of our common stock. In addition, any significant delay in consummating the Merger could have a material adverse effect on our operating results and adversely affect our relationships with customers and suppliers and would likely lead to a significant diversion of management and employee attention.

Expenses related to the proposed Merger are significant and will adversely affect our operating results.

We have incurred and expect to continue to incur significant expenses in connection with the proposed Merger, including legal and investment banking fees. We expect these costs to have an adverse effect on our operating results. If the Merger is not consummated, we may under certain circumstances be required to pay to Northrop Grumman a termination fee of $275 million. Our financial position and results of operations would be adversely affected if we were required to pay the termination fee to Northrop Grumman.

We are subject to business uncertainties and contractual restrictions while the Merger is pending, which could adversely affect our business.

The Merger Agreement requires us to act in the ordinary course of business and restricts us, without the consent of Northrop Grumman, from taking certain specified actions until the proposed Merger occurs or the Merger Agreement terminates. These restrictions may prevent us from pursuing otherwise attractive business opportunities and making other changes to our business before completion of the Merger or, if the Merger is not completed, termination of the Merger Agreement.

Uncertainties associated with the Merger may cause a loss of management and other key employees and disrupt our business relationships, which could adversely affect our business.

Uncertainty about the effect of the Merger on our employees, customers and suppliers may have an adverse effect on our business. These uncertainties may impair our ability to attract, retain and motivate key personnel until the Merger is completed and for a period of time thereafter. Employee retention may be particularly challenging during the pendency of the Merger. If key employees depart and as we face additional uncertainties relating to the Merger, our business relationships may be subject to disruption as customers, suppliers and other third parties attempt to negotiate changes in existing business relationships or consider entering into business relationships with parties other than the Company. If key employees depart or if our existing business relationships suffer, our results of operations may be adversely affected. The adverse effects of such disruptions could be further exacerbated by any delay in the completion of the Merger.

The Merger Agreement limits our ability to pursue alternatives to the Merger and may discourage other companies from trying to acquire us for greater consideration than what Northrop Grumman has agreed to pay.

The Merger Agreement contains provisions that make it more difficult for us to sell our business to a company other than Northrop Grumman. These provisions include a general prohibition on us soliciting any acquisition proposal or offer for a competing transaction. If we or Northrop Grumman terminate the Merger Agreement and we agree to be or are subsequently acquired by another company, we may in some circumstances be required to pay to Northrop

37


ORBITAL ATK, INC.

Grumman a termination fee of $275 million. Further, our Board of Directors has agreed in the Merger Agreement, subject to limited exceptions, that it will not withdraw or modify in a manner adverse to Northrop Grumman its recommendation that our stockholders approve the Merger.

These provisions might discourage a third party that has an interest in acquiring all or a significant part of the Company from considering or proposing an acquisition, even if the party were prepared to pay consideration with a higher per share cash or market value than the cash value proposed to be received in the Merger, or might result in a potential competing acquirer proposing to pay a lower price than it might otherwise have proposed to pay because of the added expense of the termination fee that may become payable in certain circumstances.
ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ISSUER PURCHASES OF EQUITY SECURITIES
Period
Total Number
of Shares
Purchased (1)
 
Average
Price Paid
per Share
 
Total Number
of Shares
Purchased
as Part of
Publicly
Announced
Program (2)
 
Amount
Available for
Future Share
Repurchases
Under the Plans
or Programs
(in millions)
July 3 - July 30
67,187

 
$
102.13

 
49,957

 
 

July 31 - August 27
14,602

 
$
103.82

 
14,532

 
 

August 28 - October 1
109

 
$
132.80

 

 
 

Quarter ended October 1, 2017
81,898

 
$
102.48

 
64,489

 
$
227

____________________________________________________________

(1) 
The 81,898 shares purchased include shares withheld to pay taxes upon vesting of shares of restricted stock and restricted stock units or payment of performance shares that were granted under our incentive compensation plans.

(2) 
During 2015, the Board of Directors approved a stock repurchase program that authorized the repurchase of up to the lesser of $250 million or 3.25 million shares through December 31, 2016, which was subsequently increased during 2016 to the lesser of $300 million or 4 million shares through March 2017. In February 2017, the Board of Directors further increased the amount authorized for repurchase to $450 million, removed the share quantity limitation and extended the repurchase period through March 31, 2018. We purchased 64,489 shares for $7 million during the quarter ended October 1, 2017. In connection with the Merger, the Company halted its share repurchase program.
The discussion of limitations upon the payment of dividends as a result of the indentures governing our debt instruments as discussed in Part I, Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations" under the heading "Long-term Debt and Credit Facilities," is incorporated herein by reference.

38


ORBITAL ATK, INC.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4.   MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5.       OTHER INFORMATION
None.

39


ORBITAL ATK, INC.

ITEM 6.   EXHIBITS
Exhibit
Number
 
Description of Exhibit (and document from which incorporated by reference, if applicable)
 
 
 
 
 
 
2.1
 

 
 
 
3(ii).1

 

 
 
 
10.1
 
 
 
 
10.2
 

 
 
 
31.1
 
 
 
 
31.2
 
 
 
 
32
 
 
 
 
101.INS
 
XBRL Instance Document.
 
 
 
101.SCH
 
XBRL Taxonomy Extension Schema Document.
 
 
 
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document.
 
 
 
101.LAB
 
XBRL Taxonomy Extension Labels Linkbase Document.
 
 
 
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document.
 
 
 
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document.
 
 
&